Speech by Danièle Nouy, Chair of the Supervisory Board of the ECB, 7th Congress of the Solvay Schools and their Alumni, Brussels, 15 October 2018

When George Bailey entered the small-town bank he managed, he could see that something was wrong. His depositors were lining up at the counter, demanding to withdraw their money. The problem was that the bank, while solvent, lacked liquidity. A bank run was under way.

“So, who is George Bailey?” you may ask. Well, George Bailey is a character from an old Christmas movie called “It’s a Wonderful Life”. And this movie tells us a thing or two about banking and ethics.

Back to the bank run. How did George handle the situation? He took the money he had saved for his honeymoon and used it to pay his depositors. That’s how he solved the crisis.

Would people these days think of George as a credible character? A banker who sacrifices his own money to help out his depositors? I have my doubts.

The reputation of bankers has suffered quite a lot in recent years. And this comes as no surprise. After all, we have seen a disturbing number of scandals: LIBOR rigging, forex manipulation, tax evasion and money laundering, to name just a few.

The result is an obvious loss of trust, and that is a problem. I don’t have to tell you that the business of banking is founded on trust – imagine trying to collect money from people who don’t trust you. And given that banking is a core element of any modern economy, this is a problem that reaches beyond the banks. It affects all of us.

So the first thing to ask is this: is the bad reputation of bankers justified, and if so, why? Is there a selection bias in the sense that the business of banking attracts less ethical people than other professions? Or is it the nature of the job? Does banking turn reasonably good people into crooks?

The answer to these questions will help us find an answer to another one: what can be done to foster more ethical behaviour?

Are bankers bad people?

Looking back, there is no doubt that a few questionable characters found their way into banks, where they caused a huge amount of damage. But this can and does happen in other industries as well. The more important question is whether the average banker is less ethical than the average person on the street.

Research suggests that this is not the case.^[1] But there is a catch. In an inventive experiment, Alain Cohn and others show that bankers are indeed as honest as people from other professions.^[2] Playing a coin-tossing game, they did not cheat more often than anyone else. This changed, however, when they first had to answer questions on their job and were therefore reminded of their professional identity: the bankers cheated more often than people from other professions.

What does that mean? The authors of the study conclude that “the prevailing business culture in the banking industry favours dishonest behaviour”. In other words: bankers are regular people who just happen to work in an environment that makes them behave less ethically than they otherwise would. Banking seems to have its own honesty norms, its own culture.

And that is a problem. After all, banking offers lots of opportunities to get rich at the expense of others – whether they are customers, shareholders or taxpayers. At the same time, it seems that banks are prone to a culture that tolerates, encourages or even pressures people to give in and seize these opportunities.

So in terms of movies, it is less “It’s a Wonderful Life” and more “Wall Street”. In “Wall Street” a reasonably good man, Bud Fox, succumbs to the unethical ways of his boss, Gordon Gekko. He immerses himself in a culture where “greed is good” and any means is justified to make money and satisfy the greed. So Bud starts to exploit insider information and only later regrets his actions and tries to correct them.

As in this film, in real life bankers might also be tempted to go further than they should in order to make money.

But how far is too far? How far should bankers go? Well, first of all, there is the law. The law draws very clear lines that constitute hard limits for everyone. But is it really that simple? It might be legally acceptable to sell risky bonds to the pensioner from around the corner. And it might be legally acceptable to pay out large bonuses even though the bank is making huge losses. But would this be ethically acceptable?

We have all learned during the crisis that such behaviour is not just unethical. It is also highly risky. Before the crisis, many banks had created and sold unethical products. In the end, however, their greed made them lose a lot of money during the crisis. And this greed still has repercussions today, well after the crisis. Just consider the size of the fines banks have had to pay for past misbehaviour, and the loss of trust they have had to deal with.

So, the law is just the last line of defence. Ethical behaviour is more than just complying with the letter of the law. When bankers take decisions, they must be aware that there is more to consider than just the legal and financial aspects.

And they must acknowledge that it is not just about them. Their actions can affect many other people. Unethical behaviour might hurt the customers of a bank – think of mis-selling. It might hurt the shareholders – think of excessive risk-taking and the subsequent failure of the bank. It might hurt investors in the markets – think of LIBOR rigging. And it might hurt taxpayers – think of bailouts. Banks have a lot of stakeholders, and if the stakeholders suffer, the banks themselves will suffer.

But how can we ensure that bankers look beyond the letter of the law? How can we ensure that they take into account the wider consequences of their actions?

Improving ethics – where to start?

When we talk about ethics in banking, we talk about people and how they behave. But what drives people to behave in certain ways? And how can their behaviour be changed?

Financial incentives are often highlighted in this context. And indeed, incentives are a powerful tool in that they help to both explain and steer behaviour. But people are not fully rational. And even if they were, the costs and benefits they weigh against each other are often more than purely monetary in nature. There is a vast personal and cultural backdrop to human behaviour, which makes changing it a very complex endeavour.

But we have to start somewhere. So let’s take a quick look at who can do what in order to foster more ethical behaviour in the financial sector.

First, there are the legislators. As I just said, ethics reaches beyond the law, but working on the hard limits still has its merits; better rules can support a better culture. Legislators must thus put in place a solid regulatory framework. This framework should limit the opportunities and incentives for bankers to behave less ethically than they should. Rules on remuneration are a pertinent example here.

But rules are worthless if breaking them has no consequences. Thus, we need a credible sanctioning mechanism. And it should not only be possible to sanction institutions when they violate the rules; it should also be possible to sanction individuals. Rules play an important role here and, frankly, we are not yet where we should be in many countries around the world, and in Europe as a whole.

Second, there are the supervisors. It is up to supervisors to establish strong expectations and adapt them to the different business models of banks. And it is up to supervisors to rigorously check whether banks are meeting these expectations. They must foster real compliance, not just box-ticking.

A former head of regulation at the London Stock Exchange recently told the Financial Times that when he “first got into this in the 1990s, compliance was called the ‘Business Prevention Unit’ all the time”.^[3] This tells us a lot about the culture that banks should get over with.

And this brings us back to the notion of culture, and back to the banks. Regulators and supervisors cannot impose a certain culture on banks, of course. This can only be done by the banks themselves.

Each bank has to define a set of values and guidelines for desired behaviour. This is the starting point. And these values and guidelines have to come from the very top, from the leaders. They must support the values, and they must lead by example. “Do as I say” will not work; it has to be “do as I do”.

For the staff, after all, desired behaviour is not defined by some document on the bank’s website. For them, desired behaviour is defined by what earns them the respect of their colleagues and managers. It is defined by what earns them a bonus and gets them promoted. And vice versa, undesired behaviour is what gets them in trouble.

But undesired behaviour has to be detected, of course; compliance has to be ensured. This emphasises the need for a strong compliance function, which must not be seen as a “business prevention unit”. Happily, a lot has been achieved here. Legislation has improved and the expectations of supervisors have become clearer. The banks themselves are also paying more attention to the issue. A clear sign is that compliance functions have become an integral part of how banks are organised. At the same time, those who manage these functions are receiving higher salaries, which in turn attracts more talented people.

So again, in a practical sense, the defined values have to be supported by checks and balances and by incentives. In other words: each bank needs a strong governance framework.

Good governance is key

There is no doubt that good governance is key in putting a lid on unethical behaviour and excessive risk-taking. However, when it comes to regulation, governance is still a fairly new thing. It was only after the crisis that it became a core feature of the rulebook.

There is an advantage, though. Governance was added at a time when everyone had subscribed to the idea of a global approach to regulation. Thus, the rules on governance are aligned with international standards, which is a good thing. Some banks could still implement these rules a bit more carefully, though.

As supervisors, we place great weight on governance. Here in the euro area it is, in fact, among our top priorities.

We have devised a comprehensive approach to assess how banks design and implement their governance frameworks. This approach is based on a wide range of supervisory tools: we assess documentation; we meet with key function holders; and, from time to time, we attend board meetings as observers. Some national supervisors, such as De Nederlandsche Bank, even have psychologists analysing the decision-making of banks’ boards. The Dutch supervisors also worked together with the Central Bank of Ireland to review the Irish retail banks’ cultures and the ethical behaviour of their staff.^[4]

All of these insights then feed into our Supervisory Review and Evaluation Process.

So what have we found so far? I will highlight just one topic: risk appetite frameworks. These frameworks are crucial to good governance. They help banks to define, communicate and monitor how much risk they are willing to take on. Thus, they draw a line that guides the behaviour of banks’ staff.

But again, this line must be more than just a line. Risk appetite frameworks must not remain abstract documents. They must become part of the bank’s collective mindset. And they need to be operationalised through precise and comprehensive risk limits – comprehensive meaning covering all business units, at all levels of the organisation.

Here, incentives can certainly help. Remuneration schemes must be in tune with the risk appetite framework. Risk modifiers and key performance indicators play an essential role in this context. We thus expect the banks to fully align them with their risk appetite frameworks.

But it’s more than just that. A good risk culture also rests on accountability. People must be held accountable for their actions – I talked about sanctions before. At the same time, a good risk culture also empowers staff at all levels to challenge decisions and to voice alternate views.

And then there is the tone from the top, of course. It is those at the very top who have to promote a sound risk culture – by putting it into practice, by acting as role models.

And this leads us back to culture, people and leadership. The people who manage a bank can shape the culture and behaviour of the entire organisation.

That is why supervisors keep a close eye on who becomes a bank manager. They act as gatekeepers and assess whether potential candidates are “fit and proper” for the job. Among other things, the fit and proper assessment is based on the candidate’s experience and reputation, and any potential conflicts of interest.

However, while rules on governance are quite new, rules on “fit and proper” are quite old. They were drafted at a time when regulating and supervising banks was a purely national task in Europe. This has two consequences. First, the rules are not as harmonised as they should be in a banking union. And second, they are not suited to the challenges of modern banking.

Ethics and supervisors

Now, let me make one final point. I have talked a lot about tone from the top and leading by example. And I have pointed out how important role models are in fostering more ethical behaviour.

So, what about supervisors? Our effectiveness also hinges on trust, and supervisors can also behave in unethical ways and cause harm. How can we lecture banks on ethical behaviour if we don’t live up to our own words? We therefore care a lot about ethics and good governance, both at the ECB and at the national supervisory authorities.

First of all, we have put in place sound rules. There is an ethics framework for ECB staff and codes of conduct for members of the Supervisory Board and the Governing Council. And there are ethics guidelines which extend to the national authorities.

Second, we have established bodies that monitor how these rules are implemented. For ECB staff, there is the Compliance and Governance Office, and for the decision-making bodies there is the Ethics Committee. And finally, there is the ethics and compliance officers task force that also covers the national authorities.

We take ethics very seriously and continue to improve both the rules and how they are implemented. We expect banks to follow our lead.

Conclusion

Ladies and gentlemen,

I have now talked a lot about governance, about checks and balances and about incentives. And yes, addressing these things will help to foster more ethical behaviour in banks.

But as I said before, the problem goes deeper. It’s a question of culture, and this makes it a very complex issue – one that we cannot resolve alone.

So it might be time to think more broadly. It’s time to look beyond law and economics. There are other fields that offer valuable insights: psychology, anthropology and sociology, to name just a few. And it might be time to look beyond the banks. There are other sectors which face similar challenges in terms of ethics. Think of pharma or medicine, for instance. How do these sectors cope? Is there anything we can learn from their experience? In this respect, I learned a lot from Mathias Dewatripont’s work on the opioid crisis.

We have to approach the topic of ethics from many angles. But the ultimate goal is clear: a shift in culture. Bankers are part of society, and they cannot sustain a culture that puts society at risk. The Gordon Gekkos have outlived themselves; the time has come to turn back to the George Baileys – honest bankers who reliably serve their customers and society as a whole. And if that sounds boring to you, well, dare to be dull!

Thank you for your attention.