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Behaviour trumps the rule book

Home / Hermes EOS Blog / Behaviour trumps the rule book

Jennifer Walmsley,
23 October 2014


Since the financial crisis, new rules and regulations have rained down on the banking sector. Governments and regulatory bodies around the world have expended vast amounts of time and energy in the pursuit of safer banks. And it is difficult to blame them. The banks destroyed vast amounts of value and it is unthinkable that that should be allowed to happen again. But are the myriad of legislative changes really the best way to guard against this?

HSBC chair Douglas Flint was recently quoted as saying that there is a real danger that regulators create “disproportionate risk aversion.” Shortly after this, two executives announced they were quitting the board of the UK subsidiary of the bank due to concerns about personal liability.

Perhaps we could argue that it is in Flint’s interests to say this. After all what bank wants more red tape? However, he is far from being the only voice on this. Veteran investor Neil Woodford has publicly sold his HSBC shares because of potentially “unquantifiable fines” for past misdemeanours.

Have the regulators gone too far?

The truth is that the financial services industry has always been highly regulated. But bankers are, by definition, problem solvers. These individuals, who are usually intelligent and invariably highly paid, saw rules and regulations as challenges to be circumvented. Legislation existed but the culture of the major banks encouraged employees to find clever ways to ignore it. There is no other industry in which the behaviour of small groups of employees has been able to have such a catastrophic impact on performance.

That is why Hermes EOS spends so much time talking to board members of banks about behaviour, often referred to as conduct risk. We ask how they satisfy themselves that behaviour is changing quickly enough and whether their management team is the right one to lead the charge. The responses vary. We hear that a board member at a US bank, when invited by a regulator to describe his organisation’s culture, retorted that he was not there to discuss sociology. Others are more forward-thinking and have thrown their weight behind efforts to change the rules of the game for good.

Regulators, it seems, have little sympathy for the banks’ complaints. The governor of the Bank of England, which supervises the industry in the UK, says that if directors feel they cannot live up to their responsibilities then they should not be on the board.

We will continue to engage on this topic because it really matters to the future of the industry. Unless the prevailing culture in banks changes, all the rules in the book will not make a difference because they will continue to be seen as hurdles to be overcome by clever bankers.

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