As the acid rain of fines and litigation costs wore away profits, last year will no doubt be remembered as the year that an ethical problem for banks became a financial one. In 2014, the fines levied by the Financial Conduct Authority (FCA) hit almost £1.5bn.
Against this backdrop, the role of regulators will come into even sharper focus this year, as every fine begs the question of why compliance remains such a challenge. With new structures in place, and almost daily evidence of enforcement, it becomes clearer that regulation alone will not solve a problem that is, at its core, cultural. And this is the lens that will be applied to our regulators in the glaring light of the first General Election since the financial crisis abated.
From the benchmarks that they measure with and the way they work with banks, to the situations in which they deem it appropriate to intervene, all these mechanisms will become ripe for transformation, albeit gradual, towards a model that places culture and regulation on a pedestal together. At boardroom lunches and conferences all over the City, that conversation is already starting to take place.
The importance of culture was overlooked in the years before the financial crisis. But there is no danger of that now. All stakeholders and regulators recognise that, in the words of the Saltz Review, “if culture is left to its own devices, it shapes itself, with the inherent risk that behaviours will not be those desired”. More crucially, there is wide acknowledgement of the limits of regulation – especially in keeping pace with technological change – and the need for an ethical response to be part and parcel of compliance with regulations.
But despite the strides being made internally by financial institutions – the culture-change success stories that rarely hit the headlines – this kind of transformation is hard, and won’t come quickly on its own in organisations which span several continents, numerous regulatory regimes and thousands of employees.
At present, the approach of the FCA is, in its own words, “to draw conclusions about culture from what we observe about a firm – in other words, joining the dots rather than assessing culture directly… and reflect that back to firms as part of the risk assessment process”. But in this fast-moving world, the question is whether public and political opinion will move to a point where this approach is no longer deemed good enough. This will heap pressure on regulators to do more, and to do it now. In the populist fervour of an election campaign, the welter of competing announcements may well include measures in this vein.
Moreover, the appetite for an evolving role for regulators is not just coming from outside the financial community. One frequently held view is that before the financial crisis, regulation was perceived only as a punitive measure that would prevent bad behaviour – clearly, that did not work.
But it is not yet clear how a more interventionist cultural model would work either. There are dangers that such a development would stifle entrepreneurialism and clearly defined leadership. Such early intervention by regulators implies that they will need to look at why decisions are being made, and to assess culture, behaviour and what is rewarded. The recently released chief executive survey from PwC underscored this need for calibration as “over-regulation” – 78 per cent of executives labelled it as the highest threat to business growth prospects, the greatest level in the history of the survey.
What is more obvious is how the regulators’ role could be developed to protect consumers – and even to assist in creating innovative new products that would benefit them. This is already underway in the form of FCA’s Project Innovate, which works with the finance industry to directly support innovators in areas such as ethical finance, helping to remove barriers to entry and increase competition in ways that benefit and put focus on the consumer. This is happening in tandem with measures to increase greater financial education and tackle the deleterious asymmetry of knowledge between banks and their customers.
Ultimately, it will be up to financial institutions themselves whether cultural change comes from within or from the outside. The competitive advantage lies with the early movers in establishing a reputation for cultural leadership. Genuinely integrated reporting, and “stress-testing” institutions’ ethical cultures through scenarios and exercises are the kinds of measures that are already being discussed inside forward-thinking institutions.
Banks must now work hand-in-hand with regulators and change their ethical culture from within. It’s going to be an interesting year, but it may be just the year we need.