Wayne Byres, Chairman ARPA, spoke at Hong Kong and discussed financial services culture. Internal failings within firms were at the heart of the financial crisis. But you cannot regulate good culture into existence he says. Standards of behaviour are far more difficult to define than standards of capital adequacy.
The FSB, Basel Committee, IAIS and IOSCO still have important pieces of work on their agenda. As each new proposal emerges, the questions are asked ‘are we almost there yet?’ and ‘how much longer?’ The answers are usually ‘not quite’ and ‘next year’. Yet work agendas do not seem to shorten, and another year rolls on ….
We are at that stage of the reform program where a great deal of time and effort is being spent on technical issues of regulatory detail: the right parameter for this, the appropriate transition timetable for that. But I sometimes think we are deciding these without enough clarity on the operating model we are ultimately working towards. My experience in Basel certainly highlighted that, when we had the greatest difficulty reaching agreement on the way ahead, it was usually because there were some underlying disagreements on the destination we were aiming for. It is like debating whether it is best to travel by car or plane on your next holiday, without first agreeing where exactly it is you plan to go.
I would suggest our task in dealing with the specifics would be easier – and we would get the work done faster – if we had a more strategic perspective on a few key issues. Those issues are the extent to which we want to design a regulatory framework founded on a degree of reliance on:
- internal models;
- supervision;
- market discipline; and
- internal governance and culture?
The reason that I highlight these issues is that all four could be said to be areas where reality has not always lived up to expectations. Yet all have the potential to act as a means of limiting the sorts of prescriptive, one-size-fits-all regulation that industry – with some justification – rails against. To put it another way, think what the regulatory framework might look like if we removed all reliance on internal models; undertook very limited supervision activities; and could not assume any form of market discipline externally, or good governance and culture internally, to act as a constraint on imprudent behaviour. The result would inevitably be a highly constraining regulatory rulebook, which assumed the lowest common denominator in all firms. Being able to relax those constraints, because there are other, better and less costly tools to help generate sound financial firms and systems, is important for ensuring regulation does not just produce financially-sound firms, but innovative and competitive ones too…..
Culture – the final frontier
The final question we need to ask is: how the regulatory framework should be shaped by the industry’s culture? To be blunt, how can we avoid just assuming the worst?
For all the weaknesses in regulation, supervision and market discipline, we know there were internal failings within firms that were at the heart of the financial crisis. Standards of collective governance, and individual behaviour, fell a long way short of expectations. Initial attempts to correct this came in the form of executive compensation standards established by the FSB, followed up by efforts to strengthen standards of governance by both the standard-setters and groups like the G30. But increasingly these are recognised as helpful adjuncts to the main game: that is, tackling the underlying culture within financial firms. It is, to a large degree, the final frontier in the post-crisis response.
I don’t think anyone on the regulatory side of the fence would be naïve enough to think they can regulate a good culture into existence. Ultimately, the financial sector will collectively determine the values it wants to uphold, and the behaviours it wants to display. Regulators and supervisors can only do so much.
I recently met with the CEO of one of the larger G-SIBs, and we spent some time talking about the efforts underway in his institution to strengthen the bank’s culture. There was certainly a major program of activity underway but, to be frank, none of it was particularly innovative or unusual. That prompted me to ask two questions:
- why was it not done before?
- what is to stop it being forgotten again once the current program has been rolled out?
I have had similar discussions and asked similar questions of a range of banks I have met with, and I am yet to get a really convincing answer. But I think it boils done to the fact that ‘doing the right thing’ has not, at least until more recently, been seen as strategically important. And, coming back to the role of market discipline, managers were not being rewarded for putting long-standing principles ahead of short-term profit.
The challenge for the industry is therefore to show genuine leadership and commitment on this issue, and not put it in the too hard basket. I do not pretend this is an easy task, and fully acknowledge that standards of behaviour are far more difficult to define than standards of capital adequacy. However, it is critical to establishing confidence – amongst regulators, let alone the wider community – that the current focus on establishing a strong, ethical culture across the industry is not just a passing fad. That will be the case when, amongst other things, developing and maintaining the right culture is seen as a core part of the organisation’s strategy, and critical for its long-term success. If that occurs, then it is more likely reality will match expectations.
