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The relevance of the supervision of 
behaviour and culture to the SSM

Speech by Julie Dickson, Member of the Supervisory Board of the European Central Bank,
at the conference "Looking forward: effective supervision of behaviour and culture at financial institutions" in the Tropenmuseum and organised by De Nederlandsche Bank,
Amsterdam, 24 September 2015

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Julie Dickson gives a keynote address at De Nederlandsche Bank (DNB) in Amsterdam. At a conference focussed on supervision of behaviour and culture at financial institutions, she says that DNB has taken a leading role in emphasising the role of behaviour and culture in financial institutions.

Ms Dickson then explains the importance the Single Supervisory Mechanism (SSM) places on corporate governance, noting that a key priority in 2015 was a thematic review on risk governance and risk appetite in the 123 banks directly supervised by the SSM which, she confirms, is now close to completion. She says the review is providing valuable insights, which are important for this year’s Supervisory Review and Evaluation Process process; and also for providing a basis for planning next year’s supervisory cycle.

She points out that the review has been a new experience for many banks, some of which are not used to answering the kind of questions the SSM is asking, such as why boards believe their risk appetite framework is appropriate, or why they believe the information they are getting from their management teams is appropriate. She says the review also touches on incentives, by asking questions regarding the consequences for employees within an institution of not respecting the risk appetite framework and by exploring whether the risk appetite framework encouraged the desired risk-taking behaviour.

She says that though the review is an initial one, over time, as its knowledge of each bank grows, it is to be expected that such assessments by the SSM will go deeper.

She then underlines the huge opportunities that bringing together supervisors of 19 different countries can offer and notes that the SSM is consulting the DNB to explore how to make optimum use of their staff and to better understand their approach.

She also speaks about the ECB’s position on supervisory participation in regular bank board meetings. She says that the ECB’s current view is that supervisors should meet with boards as needed to deliver supervisory messages, and may also attend part of a board meeting from time to time to watch and to see what information is being provided and what questions are being asked; but that it will not attend as a general rule.

Finally, she touches upon the challenges confronting the ECB in its work to harmonise differing transpositions of the Capital Requirements Directive. She says that when the ECB has to assess the suitability of new bank board members, it is confronted with very diverse national rules and practices. And that although it can go some way towards harmonising rules on suitability of the management body, it cannot harmonise specific items laid down in national law. She says that in areas like fit and proper assessments, it is therefore not easy to spread best practices across the 19 SSM countries. And that the ECB is seeking more changes to bank regulation in Europe.

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I am very happy to be here to discuss governance, culture and behaviour, and supervision, as I think this is an important field and one that is increasingly being discussed globally.

De Nederlandsche Bank (DNB) has played a leading role in emphasising the role of behaviour and culture in financial institutions. DNB also played an important role in the Financial Stability Board (FSB)’s Supervisory Intensity and Effectiveness (SIE) Group when it issued the 2014 “Guidance on Supervisory Interaction with Financial Institutions on Risk Culture”. At that time, major global supervisors agreed that weak risk culture was a root cause of the global financial crisis, as well as a cause of major compliance breakdowns since the crisis began.

The FSB guidance was issued to assist all supervisors in identifying practices, behaviours and attitudes that may influence an institution’s risk culture. In a nutshell, the FSB guidance set out indicators (not a checklist) that were important elements of a risk culture, including the tone from the top, accountability within the institution, effective challenge within an institution, and incentives for employees. The FSB guidance asks that supervisors pay attention to these areas and raise any concerns with boards – something supervisors are well placed to do given their frequent interaction with the banks.
DNB and the FSB are not the only bodies that have published important work in this regard. The Group of Thirty (G30) recently published a report that called out banks’ limited progress in staying on top of culture. While calling for more action by the banking industry, the report also provided case studies of some successes

in the industry, while suggesting new techniques that banks should adopt to succeed in this area. The report also noted the value prudential supervisors have added on this front. The G30 emphasised that banks that take half-hearted actions to try to deal with the issues of culture and behaviour (for example so as to reduce the level of fines they might face) will not succeed. Banks will only succeed if they take the position that culture is core to their business model, and if they also decide that fixing culture is key to their economic sustainability.

So the FSB, the G30 and DNB seem fairly united on the need to deal with culture. Before going on to talk about what the Single Supervisory Mechanism (SSM) is doing, let me also say that the topic of behaviour and culture has been embraced by many others. Several years ago, Warren Buffet’s long-time business partner, Charlie Munger, advocated more psychologists in private corporations, as he felt they could help in understanding the role of incentives and how they drive human behaviour. So from that perspective, this topic is not new.

The SSM has been operating since 4 November 2014 – a period of approximately ten and a half months. Our goal is to contribute to the safety and soundness of credit institutions and the stability of the financial system as a whole within the euro area. It was created to deal with possible “home bias” of national supervision, which created an environment which allowed jurisdictions to promote national champions and to support local banking models, which may have led to a less strict stance regarding the risk behaviour of banks. The SSM is responsible for the largest 123 banks in the euro area.

The SSM has been busy since its creation. One of its tasks has been to create a common supervisory methodology. In terms of corporate governance, I can sum up that methodology by saying that it fosters engagement of supervisors with the boards of banks and encourages a great deal of interaction between the supervisor and boards and senior management. To underline the importance we attach to governance, a key priority established on day one was a thematic review on risk governance and risk appetite in the 123 banks that we directly supervise, which we are close to completing.

The Joint Supervisory Teams, which exist for every significant bank and are responsible for their supervision, were in charge of the practical implementation of the thematic review. The governance assessments feed into the supervisors’ general view on an institution, along with elements such as the institution’s business model, risk management, and capital, liquidity and funding (the whole process is known as the Supervisory Review and Evaluation Process, or SREP). The assessments are providing valuable insights, which are important for this year’s SREP process. They also provide a basis for planning next year’s supervisory cycle.

Another aspect is worth emphasising. Given that the sample size is 123 banks, the review is providing a lot of information on existing practices in Europe. This not only arms us with solid information about best practices that we can convey to banks, but also helps ensure consistency across Europe. In the review we learned that practices were not the same across the 19 countries, neither in terms of what supervisors were doing nor what banks were doing.

The supervisory tools used during the risk governance and risk appetite thematic review included the assessment of minutes and related documentation, holding meetings with key function holders and attending some bank-internal meetings as observers. Findings from on-site inspections (if there had been any) were also incorporated. On the basis of the bank-by-bank assessments, we take a horizontal approach to guarantee consistency in how the findings’ severity is being assessed and to identify possible remedial actions and best practices. To foster the engagement with boards and key function holders, supervisors will share this autumn the results of the thematic review with the institutions and provide them with feedback on where they stand in relation to peers.

The SSM review has been a new experience for many banks, some of which are not used to answering the kind of questions we are asking, such as why boards believe their risk appetite framework is appropriate, or why they believe the information they are getting from their management teams is appropriate. While our review is not a behaviour and culture assessment of the type that our Dutch colleagues have been employing, it does touch on culture, by exploring how the board makes important decisions and the quality of debate surrounding those decisions, including the information boards have and how risk is taken into account. Our review also touches on incentives, by asking questions regarding the consequences for employees within an institution of not respecting the risk appetite framework or corporate values in relation to risk, and by exploring whether the risk appetite framework encouraged the desired risk-taking behaviour.

The final point I should make on the horizontal review we are completing is that it is an initial review. There were necessarily limits on the depth of the review, given that 123 banks were covered and that we wanted it to be completed in time to feed into the SREP process. However, over time, as our knowledge of each bank grows, it is to be expected that such assessments will go deeper.

In our horizontal review, the supervisory staff at the ECB and the staff at the national competent authorities, including the DNB, worked together.

The task the ECB currently faces to harmonise practices in Europe and implement tough but fair supervision is very challenging. At a minimum, we need to be sure that general supervisory practice is implemented well, while also staying on top of new developments and approaches. While bringing together the supervisors of the 19 countries that use the euro presents its challenges, there are huge opportunities: one is the ability to work closely with supervisors in Europe and consider some unique approaches, such as the Dutch supervisory approach where risk and behavioural issues are front and centre, in one compartment of the supervisory toolbox. As we gain experience in our supervisory role, and as our knowledge of the 123 banks we supervise grows, we will be better placed to understand where to focus our resources. We have not hired psychologists at the ECB, but we are consulting the DNB to explore how to make optimum use of their staff and to better understand their approach.

While globally many agree on the need for risk culture work of some type, there are some people with other views. Two examples come to mind.

First, at a conference I was speaking at on this issue, some in the audience suggested that bank supervisors should forget any work on culture and just levy substantial fines on unsavoury characters in banks to teach them lessons and set an example. The message was that we should prosecute people, not firms. While the recent examples of enormous fines globally are no doubt a deterrent – and some note that jail terms could add to the deterrence factor – a strong prudential supervisor should also act to prevent the problem from arising before there is even a need for prosecution. The cost of a systemic bank failure or of a financial crisis and the disruptions that follow are such that every effort must be made to stamp out behaviour that leads to bad outcomes. It is not sufficient to simply ignore behaviour in banks that could lead to trouble. And we know a lot more today about the types of behaviour that really matter for banks, and we need to focus on them. That is why the SSM, in doing its thematic review, included some questions on behaviour and risk culture.

Second, I was asked once whether it makes sense to do such work because the main value in banking is money and profit making, which is incompatible with risk culture. But, in my view, risk culture is 100% compatible with taking risk and making money. A sound risk culture helps ensure that activities beyond the institution’s risk appetite are recognised, assessed, escalated and addressed in a timely manner.

This conference is also a good opportunity to clarify the ECB’s position in another important area: supervisory participation in regular board meetings. Prior to the creation of the SSM, there were different practices in this regard. For example, some supervisors sat in on all board meetings, sometimes because they were required to do so under national law. Our current view at the ECB is that we will meet with boards as needed to deliver supervisory messages. We may also attend part of a board meeting from time to time to watch and to see what information is being provided and what questions are being asked – but we will not attend as a general rule.

Finally, while our intent is to see a single set of practices applied across the 123 banks that we supervise in the 19 countries, there are limits as to how far we can go. For example, the Capital Requirements Directive IV (CRD IV) has been transposed into national law in different ways. So, when the ECB has to assess the suitability of new bank board members, it is confronted with very diverse national rules and practices: for instance, some authorities make use of questionnaires to be answered by the candidates (which, when they exist, are not harmonised from one country to the next), while other authorities conduct interviews with new board members. The national timelines for conducting the assessment also greatly differ. The criteria laid down in CRD IV to assess the suitability of the management body (for example, on reputation and the number of directorships) are interpreted differently in the national laws. While we can go some way towards harmonising the latter, we cannot harmonise specific items laid down in national law. In areas like fit and proper assessments, it is therefore not easy to spread best practices across the 19 SSM countries. Thus, we are seeking more changes to bank regulation in Europe.

In summary, corporate governance of the significant institutions we supervise is a very important part of our supervisory work. In this regard, our priority has been to do an assessment at a high level of governance practices at 123 banks in our first year as a supervisor. In so doing, we have touched on the area of culture. We have also decided to work closely with our Dutch colleagues to learn about their approach and determine whether and how it could be applied to a larger number of banks.

Thank you for your kind attention.

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