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Being good pays off: how ethical behaviour affects risk, reputation and returns

Speech by Danièle Nouy, Chair of the Supervisory Board of the ECB, The Communicators Conference, Frankfurt, 12 November 2018

In the 1950s, cars were still something new for many people. They were an impressive invention and a symbol of wealth and prestige. But people were also aware just how powerful and dangerous cars were, so they took learning to drive them very seriously. Hence, there were a lot of manuals on how to handle these new machines. And most of these manuals had a distinctly moral undertone.

A particularly popular manual from 1955 says: “The motor age citizen must accept the moral responsibility of properly using the power machines he has devised.”

Wouldn’t that sentence be entirely appropriate for a bankers’ manual as well? What is finance if not a powerful machine? It can nurture economies and help them grow; but it can also destabilise and destroy them. This complex machine needs to be operated very carefully and with a strong sense of responsibility.

Yet many people think that bankers, in recent years, have neither shown much care or responsibility. And I mean more than just the financial crisis. Some bankers have misbehaved in other ways: LIBOR rigging, forex manipulation, tax evasion and money laundering, to mention just a few of the things that have come to light recently.

This misbehaviour has destroyed a lot of trust over the past few years. And this has certainly hurt the bottom line: no trust, no profits. Trust is the single most important thing a bank needs to do business. This is old wisdom backed up by new research.[1] So, banks have a huge problem here. And given the importance of banks to the economy, we all have a problem.

But let me emphasise that not all bankers misbehaved, of course. It was a few black sheep who caused great damage and tarnished the reputation of an entire industry. Or was it? Research suggests that the professional identity of bankers does indeed make them more prone to unethical behaviour than is the case for other professions.[2] This does not mean that bankers are bad people per se, but it still hints at cultural issues in the industry.

And indeed, a cultural shift in banking is the one big thing that is needed. Without it, all the other tools and measures to foster ethical behaviour will be far less effective.

But what is culture? Well, it is a soft concept that is hard to pin down. There are some useful definitions, though. Consider this one: culture is “a system of shared values that define what is important, and norms that define appropriate attitudes and behaviours for organisational members”.[3]

It is now up to the banks to change the values on which they base their actions. And to begin with, this change has to come from the top. The leaders of a bank have to redefine the values and thus reshape the culture – and they must do so in a credible manner. This means they must do more than just talk; they must lead by example. Actions speak louder than words.

And then they have to modify the inner workings of the bank. Compensation schemes are a good example. If people are rewarded for doing risky or outright unethical things, they will have no reason to stop. Thus, bonuses and promotions must be awarded for good behaviour. At the same time, people who misbehave must be held accountable and be sanctioned.

But culture doesn’t only develop top-down. It is also shaped by the staff of a bank. Tell me whom you hire, and I tell you who you are. Naturally, banks try to hire people who fit into the existing culture. This, of course, creates a feedback loop which reinforces this culture.[4]

So, if banks are serious about a cultural shift, they have to accept more diversity. Critics, devil’s advocates and whistle-blowers all help to facilitate cultural shifts. And the important thing is not just to have them, but to listen to them. Thus, staff from all levels must be able and encouraged to speak up when they see problems. And management must listen.

So, both managers and staff play important roles in shaping culture. Another factor is the environment. I already talked about reputation and trust, which provide a direct link to customers, investors and the public. These outsiders can put pressure on banks. You, as heads of communication, might feel that kind of pressure from time to time.

And it’s not just moral pressure; it’s also financial pressure. If investors and depositors turn their backs on a bank, the bottom line will suffer. So, the environment can have a strong influence on a bank’s culture.

Another part of the environment is regulation, of course. First, there is the law, which strictly limits behaviour. There are things that are legal, and there are things that are not. But the law should just be the last line of defence when it comes to ethical behaviour. As Seneca said: “Shame may restrain what the law does not prohibit”.

But even though ethics reaches beyond the law, it still makes sense to work on the rules. Better rules can support a better culture and, thus, more ethical behaviour. Good rules can limit both the incentives and the opportunities bankers have to behave less ethically than they should.

A key feature of such rules should be adaptability. The business of banking is not only complex, it also moves very fast. The big machine of finance constantly churns out new products and new instruments. Some of them are good and useful, others are questionable. It’s the latter that might offer new opportunities to misbehave, to mislead customers, to bend the rules and to make money at the expense of others. So, rules must be flexible enough to keep pace.

But what is the purpose of rules, if breaking them goes unpunished? Rules are worthless unless they are paired with 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.

So, rules can influence the behaviour of banks. And we supervisors can do so as well. Of course, it’s not in our power – or mandate – to change a bank’s culture. But we can still help to foster more ethical behaviour.

What we look at in this context is the governance of a bank. Because ultimately, it provides the necessary checks and balances, that sets incentives for good behaviour and limits to bad behaviour. Good governance can take banks a long way towards a sound culture.

That’s why we take governance so seriously. We have devised a comprehensive approach to assess how banks design and implement their governance. This approach is based on a wide range of tools. For instance, we assess documentation, we meet with key function holders; and, from time to time, we attend board meetings as observers. All the insights we gain feed into our Supervisory Review and Evaluation Process.

Regarding our findings, I will mention just two things.

The first thing relates to something I said before. Eventually, it’s the people who shape a bank’s culture. In particular, the people at the top play a key role. So banks have to carefully assess whom they hire.

But it’s not just up to the banks. It’s also up to us supervisors. We too assess whether candidates for executive positions in banks are “fit and proper” for the job. We look at their experience, their reputation and potential conflicts of interest.

This is something that supervisors have done for quite some time. That is good, of course, but it’s also a problem. The rules on these “fit and proper” assessments were written a long time ago. They were written at a time when supervising banks was still a purely national task here in Europe.

The result is that the rules are not as harmonised as they should be in a banking union. And on top of that, they are not tailored to the challenges of modern banking. It would be good to base future appointments of bank executives on rules that are the same across Europe and that fully take into account the lessons learned from the financial crisis.

The second thing that determines whether governance is really good are the actual checks and balances. And here, banks’ boards play a key role. Their job is to challenge, approve and oversee how the management implements the bank’s strategic objectives, its governance and its corporate culture.

Over the past few years, banks have made a lot of progress in composing and organising their boards. But there are still areas where they could do better. In very general terms, banks could be more aware of how important the board’s oversight function is. From this, everything else follows.

First of all, board members have to be carefully chosen; this links back to the “fit and proper” assessments I just mentioned. A key requirement is that boards have a sufficient number of independent members; only then can they truly challenge the management. And it’s not just formal independence that counts; it’s also independence of mind. In this regard, some banks could do a bit more.

At the same time, boards need to be of a reasonable size. When there are too many people sitting around the table, discussions become less focused. And some banks do have very large boards.

Finally, the collective expertise and experience of a board must be well balanced and relevant. As banks struggle to adjust to the digital world, boards must build expertise in IT-related issues, for instance. Otherwise, they will not be able to do their job.

Ladies and gentlemen,

Let’s turn back to the driver’s manual I mentioned at the beginning of my speech. It also says that the “mental make-up of a driver is more important than his skill. It determines what he will do when he has power in his hands”.

Now, bankers need the right skills to do their job, of course. But banking is also a question of attitude. The core role of banks should be to reliably serve the economy, in other words, to serve all of us. Subscribing to this idea is the first step towards a sound culture that fosters more ethical behaviour.

I know that banks have issues that are closer to their heart: the bottom line is probably at the top of the list. But as I have argued, being ethical does help the bottom line too.

At the same time, though, I doubt that this is the right angle in the first place. Can we really measure ethical behaviour against the yardstick of the bottom line? Wouldn’t that imply that banks should forget about ethics as soon as it starts to hurt profits? That’s not how I see it; and I hope that I am not alone here. Behaving ethically should always be the starting point.

Thank you for your attention.

  1. Ampudia, M. and Palligkinis, S. (2018), “Trust and the household-bank relationship”, ECB Working Paper, No 2184, October.
  2. Cohn, A., Fehr, E. and Maréchal, M.A. (2014), “Business culture and dishonesty in the banking industry”, Nature, Vol. 516, pp. 86-89.
  3. O’Reilly, C.A. and Chatman, J. (1996), “Culture as social control: corporations, culture and commitment.” In: Staw, B.M. and Cummings, L.L. (eds.), “Research in organizational behavior”, pp. 157-200. Greenwich, CT.
  4. Lo, A.W. (2015), “The Gordon Gekko effect: the role of culture in the financial industry”, NBER Working Paper, No 21267, June.

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