“Diversity is the best bulwark against groupthink”

Interview with Ed Sibley, Member of the Supervisory Board of the ECB, Supervision Newsletter, 15 August 2018

Ed Sibley, Deputy Governor of the Central Bank of Ireland and ECB Supervisory Board member, discusses the importance of all forms of diversity to the governance, culture and risk profile of banks, the state of the Irish banking system and the benefits of supervision across Europe.

We have seen a lot of regulatory changes and new rules for the banking sector in Europe in the aftermath of the financial crisis. Where do you still see room for improvement?

The changes to regulatory rules, infrastructure, approach and mindset have undoubtedly enhanced the safety and soundness of the banking system across Europe. Enhancements in the macroprudential toolkits and their use and, at the other end of the spectrum, in conduct rules and supervision, have helped ensure that the lessons from the build-up to the last crisis have been applied.

Some areas for enhancement still remain. However, as we undertake the necessary refinements, we must not let the memories of the economic and human costs of the last crisis fade too much, such that the post-crisis reforms are significantly weakened.

Currently, there is a strong focus in Europe on the completion of the banking union and capital markets union. In relation to banking union, we must do more to ensure that we can resolve banks without recourse to home country taxpayers or significant national or European financial stability risks.

I would also highlight two areas for vigilance and enhancements. First, the enhancements made thus far have rightly been driven by the lessons from the last crisis. For this and other reasons the next crisis will undoubtedly be different. So we need to remain vigilant, be forward-looking and increasingly analytical to anticipate different risks and systemic issues, particularly in view of the rapid and far-reaching technological disruption that is taking place.

Second, a strengthened regulatory book and enhanced supervision have delivered a safer and sounder banking system. But there are risks in overly focusing on rules and our activities. We need to have a sharper focus on the supervisory outcomes we are seeking to achieve, to ensure that our actions are effective in understanding and mitigating risks.

In the Central Bank of Ireland you have done a lot of research and analysis regarding diversity in banking. What are your key findings and insights?

Based on the weight of research evidence and our own experience, we at the central bank consider that diversity in all its forms is important to deliver our mandate of serving the public interest by safeguarding stability and protecting consumers. Low levels of diversity increase the risk of over-confidence in decision-making, a lack of internal challenge and an excessive resistance to external challenges, and resistance to change. Groupthink and a lack of challenge can also result in over-reliance on a core set of assumptions and beliefs. Diversity is therefore an important factor in a firm’s governance, culture and risk profile, and of direct relevance to us as regulators and supervisors.

Our research published in 2017 and 2018 on the degree of gender diversity at senior levels in regulated financial services organisations shows a significant gender imbalance. For example, between 2012 and 2017 about 80% of the most senior appointments made in banks operating in Ireland were awarded to men. This year, we have undertaken a deeper dive on the levels of diversity and the work banks are doing to improve diversity and inclusion. I would highlight three key findings.

  1. By most measures there is a lack of diversity at senior levels in Irish banks. There has been some recognition of the need to address weaknesses in skill sets (e.g. IT), but there is much less awareness of the need to tackle extrinsic and intrinsic diversity. The modicum of progress that has been made at supervisory board level is not reflected at the executive/management level. Gender imbalances at senior levels are even more acute in those roles that generate revenue and drive the business – such as chief executive officer, chief financial officer, heads of retail, and so on. Over the last six years 94% of appointments into these roles have been awarded to men, typically men with similar backgrounds and experiences.
  2. The increased focus on diversity and inclusion is relatively recent for the banks reviewed, with most only taking steps to become more diverse and inclusive over the past year or two. And there are significant differences in the maturity and ambition of the approaches taken by the banks to diversity and inclusion.
  3. Not enough data are being collected and initiatives to improve diversity and inclusion are not generally being assessed and measured to ensure their effectiveness. There is evidence of this changing, with the more advanced banks starting to set tangible diversity and inclusion goals (typically related to gender).

These and our other findings show that the risks I touched on earlier remain elevated. Without further intervention, these risks will remain outside the scope of risk appetite for some time to come.

What are you at the Central Bank of Ireland doing to mitigate these risks – also when it comes to your own institution?

Diversity will continue to feature strongly in our approach to further enhancing the resilience of the financial system and to preventing and mitigating the impacts of future crises.

To mitigate the risks I have outlined and for reasons related to our public service mandate, and also to hold ourselves to the standards we expect of regulated firms, we are continuing to enhance our own approach to diversity and inclusion. We are building from a strong base, from a gender perspective at least. The Central Bank strongly outperforms the financial services sector, the Irish public sector and our European peers in terms of seniority and pay. From the Board down through our executive and senior leadership levels, there is a good balance. More than one third of our board are women, as are 40% of our executive committee and 43% of our leadership team. And we are committed to doing better.

Groupthink was a key weakness in the run-up to the last financial crisis. To what extent have financial institutions successfully addressed this?

Groupthink was a critical issue in Ireland. It was evident throughout the financial, political and regulatory system and contributed to the depth and impact of the crisis. This is one reason we are emphasising diversity of thought so highly, as it acts as a bulwark against groupthink. But there is still much to be done in this area.

More generally, we all have our biases and rely on implicit and explicit beliefs and assumptions, some of which may not be reliable over time. There will inevitably be future “black swan” moments where these assumptions unravel. The risks of these moments can be mitigated to some extent by financial institutions and their regulators seeking to understand and then continually challenge and test these assumptions and beliefs, heed alternative views and explanations and strive to avoid complacency.

Do you see room to impose diversity targets and comply-or-explain rules on banks?

Targets can work well in certain areas and may have a role to play in improving diversity in financial services, but they have limitations. Our objective in Ireland is to encourage diversity of thought and perspective, not just a proportional representation of various demographics. I am not opposed to targets, but I think there are better ways to encourage firms to make sustainable changes to their pipeline of talent to ensure better governance at all levels.

Banks must take ownership of their talent pipeline and put in place structures that provide the diversity of voices necessary for the constructive challenge that produces better business outcomes. It is in their best interests to do so. That said, if they do not take the necessary action, the legislator and/or supervisor should.

We at the central bank expect that all banks operating in Ireland will address the lack of diversity at senior levels. Our expectations include that banks’ boards and senior management:

  1. have approved and put in place diversity and inclusion policies which are subject to annual review and regular discussion
  2. actively consider the construction of the board, the executive and key committees to identify actions that would enhance the levels of diversity of thought and effective challenge within them, and so improve decision-making and risk management
  3. have approved and are taking forward a clear plan to implement these actions

There is evidence of some progress, and my preference is for the banks to deliver the necessary improvements themselves. However, if diversity does not improve at senior levels, the central bank will have to consider whether further specific requirements should be introduced.

Are the Irish banks out of the doldrums? What do they still need to do?

Ireland has a diverse banking sector, with a growing internationally-focused segment that has been broadly profitable and relatively stable over the last 10 years, albeit with one or two notable exceptions. However, Ireland’s domestic retail banking sector was catastrophically hit by the crisis, and we have been through a long period of crisis management. We are emerging from this period, with banks returning to healthier net interest margins, improved cost-income ratios and more sustainable profitability. Balance sheets are stronger, funding profiles more resilient and there have been significant improvements in many other areas – including very significant reductions in non-performing loans (NPLs).

But there is still work to be done to address these prudential and conduct legacy issues with finality. I have said previously that the Irish banking sector must ensure that the holes in the roof from the last storm are mended long before another set of storm clouds appears on the horizon. Indeed, now is the time to ensure not just that the holes are mended but that the roof itself is strong enough to keep out future storm water. This is particularly important in Ireland, given the openness of the economy and its strongly cyclical nature. These factors have contributed to our decision to raise the countercyclical capital buffer in Ireland to 1%, to further enhance the resilience in the system. We expect the banks to be thinking in the same way.

Irish banks, like banks across Europe, will need to continue to invest in technology to ensure that they are providing the services that customers expect from a functionality and availability perspective, while ensuring that they are resilient and mitigating cyber security risks.

In your view, how has the harmonisation of supervision at the European level helped Irish supervisors, or helped Irish banks?

I hope that harmonisation is a two-way street. I am committed to ensuring that the central bank continues to proactively contribute to the success of European banking supervision. More broadly, we are also committed to greater supervisory convergence, rigorous supervision across all sectors and operating to and influencing European norms.

Our approach to banking supervision, which was revolutionised after the onset of the crisis, has evolved further through our engagement within the Single Supervisory Mechanism (SSM). Notably, we changed our approach to on-site inspections to align with the SSM methodology and have subsequently enhanced our approach to inspections across other sectors, having learned from their successful implementation in banking supervision.

Supervisory harmonisation has also been hugely important in dealing with critical issues such as NPLs and Brexit. In both these areas, the system has benefited from mitigating regulatory arbitrage and from harmonising approaches, and from the degree of independence the SSM provides. I believe that the Central Bank has made a strong contribution to how we have dealt with these and other issues.

The banks themselves were on an upward trajectory, but they are undoubtedly even stronger and better run as a result of our collective interventions, although there are still issues that need to be dealt with. And they are now more focused on peer comparisons beyond Ireland, which is important.

Do you see particular areas where national supervisors across Europe can learn from each other?

A multitude! I have an extremely privileged position as a member of the Supervisory Board in seeing the issues across all the significant banks and the approaches being taken to address them. This happens at all levels, with my teams engaged with ECB and other national supervisors on a daily basis. One good example is the support we have had from De Nederlandsche Bank on the behaviour and culture review I referred to earlier; another is the use of multinational teams for on-site inspections.

As I look forward, I would prioritise the need for greater collaboration in relation to technology. This needs to consider both the opportunities and changes arriving through financial innovation and the explosion in data, and also the threats connected with cybercrime risks and our increasing reliance on technology.

Media contacts