2014 Chambers Memorial Research Lecture

Risk Culture in Financial OrganisationsMichael Power

London School of Economics and Political Science

1

3rd April 2014University of Sydney

Plan

• Risky culture• Our study• Findings:

– Structural change– Instruments– Trade-offs

• Discussion

- 2 -

Risky Culture

“Banks have failed because those leading and managing them failed. Much criticism has been levelled at the city culture which encouraged excessive risk taking. The banks’ boards must also take their responsibility for failing in their duty to establish a culture within their institutions which supported both innovation and risk management.” (UK House of Commons Treasury Committee 2009)

3

Risky Culture

“In contrast to JP Morgan Chase’s reputation for best-in class risk management, the whale trade exposed a bank culture in which risk limit breaches were routinely disregarded.” (Permanent Subcommittee on investigations, United States Senate, March 2013)

4

Risky Culture

“There was an over-emphasis on short-term financial performance, reinforced by remuneration systems that tended to reward revenue generation rather than serving the interests of customers and clients. There was also in some parts of the Group a sense that senior management did not want to hear bad news and that employees should be capable of solving problems. This contributed to a reluctance to escalate issues of concern” (Salz Review into Barclays Business Practices, April 2013)

5

Risky Culture

Moral panic? New kind of linkage between culture and perceived harm (culture as risk object -Hilgartner, 1992)

‘Risk culture’? a more focused framing of culture problem; risk-

taking – excessive, ungoverned, misunderstood. FIs must ‘actively assess and manage the risk culture’

(G30, 2012) = Pressure for action but…..

6

Risky culture

…..explosion of interest without clarity about how to operationalise;

“We simply do not know if we have the tools to change the banking culture.” (UK Financial Services Authority Chairman, 2010)

= Interest in culture is firstly a symptom Common theme of post-disaster examination

e.g. Challenger Launch and NASA; Deepwater Horizon & BP (“Normalized Deviance”)

7

Our study

Researchers: Mike Power (LSE/CARR); Simon Ashby (Plymouth); Tommaso Palermo (LSE)

Public and private sponsorso Economic and Social Research Council (ESRC); Chartered

Institute of Management Accountants (CIMA); Chartered Insurance Institute (CII); The Lighthill Risk Network

May 2012 - September 2013; published report Implicit expectations: a new tool for behaviour

modification; Work ongoing in a number of areas

8

Our approach

Neutralist: not looking to strictly define risk culture or the elements of a ‘good’ culture: but to see how it is being assembled as an object of concern inside financial organisations

Bottom-up: work with CROs in 15 FS organisations and other relevant actors to explore view of ‘risk culture’ and their workstreams

Comparative: Across banks and insurers, and with an airline

9

Findings 1: structural change

Post crisis increased central controlNew risk oversight units – information

consolidators and aggregators Strong regulatory interest in the ‘three lines of

defence’ as structural solution Pre-crisis: 2nd line broken; Post-crisis: 1st line

(culture) or nothing (UK PRA)NB trade-off: business risk capability vs

structural independence10

Growth of interest “toolkits”o From regulators; Boards, Risk committees, Independent

Directors; Pressures to move risk culture from programmatic to operational level; search for actionability

o Growth of advisory markets; culture diagnostics; gap analysis

Risk culture vs. risk culture toolkits (instruments)o Risk culture: expands complexity of environments,

overflows organisational boundaryo Risk culture tools as starting point: reduction of

complexity, internalisation 11

Findings 2: risk culture instruments

Findings 2: risk culture instruments

• Our approach: survey instruments became interesting as artefacts themselves (accounting instruments). How actually used?

• Do not just ‘measure’ risk culture; they construct facets of risk culture for attention.

• Survey instruments (e.g. McKinsey and others); culture scorecards across e.g. ease of escalating concerns, leadership style, risk training)

• Others build on group-grid theory as an underlying conceptual framework

12

Findings 2: risk culture instruments

13

UK Institute of Risk Management on risk culture (2012)

Findings 3: trade-offs

o Surveys show risk culture multidimensional, not a single thing

o Varies across factors and within organisations o Our view: versus optimal, ideal model of risk

culture, more a bandwidth where extremes equally undesirable

o risk culture(s) emerges in the space of multiple trade-offs (“trading-zones”)

o Observed in prior literature on safety culture (Reason); equally visible in finance

14

Trade-offs: an example

Long landing trade-off example Happening on very long runways in the

summer primarilyWeather is nice, reduce time, fuel,

environmental costs… It all looks good; right?

But…

15

Between risk and control

Risk appetite/risk culture relationship; how risk appetite actually happens (the life of KRIs)

All FOs use limits but subtle differences in approach and attitude

“Sandbox guardians”o Limits as a means to an end; Business decision-

facing “Gold-platers”

o Limits and rules become a system in their own right and expand; more potential for decoupling

16

The authority of the risk function

Business partner or independent advisor?o Role ambiguity: ‘Am I the policeman, am I the

friend, am I a critique?’

‘Partnership builders’o Engage with the business as trusted advisors; the

‘pragmatic’ risk manager

‘Partnering overseers’o Influence the business via risk training etc.

17

Networks and interaction

Informal network building (Interactive controls) or formal processes?

Touch point ‘enthusiasts’o Internal networking, cross-functional

interactions; interaction important in crises (Weick)

Touch point ‘realists’ (pure 2nd line)o Accountability and decision-making issueso ‘Going native’ problem

18

Trade-offs and prescription

So what? Observed trade-offs as basis for devising practice-oriented questions (“Smart and dumb questions to ask about risk management” RiskWatch, Canadian Conference Board 2010.

“Smart” questions force clarity about trade-off choices; require empirical knowledge; are difficult to answer

Making risk culture change: pragmatic, empirical, focused on ‘moments that matter’ (PwC) vs culture as totality

19

“Smart” question examples

How can you monitor changes in internal authority of, respect for, risk and control functions? Do you track changes in nature and quality of risk/business interaction?

When limits and tolerances changed, is the risk function a leader or follower?

Do leaders have an appetite for acquiring risk knowledge? Are they open to exchanges with outsiders? Do leaders create organisation success stories about risk

Where in organisation is behavioural change most needed (‘STAR’ culture?)

How wide is participation in stress testing? In updating BCP plans?

20

Discussion

‘Smart’ questions: ‘nudging’ risk culture vs engineering approach; Changing risk culture is risky; cannot push too hard?

Tracking the moving parts that matter; creating conversations in the business;

New measures vs old KRIs; wanting to know new things? E.g CRO/CEO/CFO contact

Meta-analysis: ‘joining the dots’ approach (UK FCA)? Making the risk culture visible; always partial, pragmatic

21

Discussion

Our ‘bandwidth model: Good vs bad risk culture perhaps to do with organizational clarity about trade-offs that matter, and appetite to track changes.

Not level of risk-taking as such? Thought experiment to imagine a ‘good’ risk culture which is adventurous?

Organisational self-awareness: New role for internal audit of culture much discussed in UK

A new kind of ‘risk culture’ auditor? Like regulator joining dots.

22

Discussion

In our research we saw shifts in performance contracts to include control and risk factors. Behaviour may change but is this really cultural change?

‘Ethical’ renewal of Banks? Is this really realistic? Internalising voice of the client as ‘thin’ ethics.

Will banks ever get capital credit/debits for risk culture? Only if culture can be accounted for an made auditable?

23

Discussion

The Risk Culture Explosion: assumption that banks can fix themselves; extension of corporate governance self-regulatory space; culture as (internal) control

Alternatives to behaviour modification via risk culture: prohibition plus strong enforcement? And/or structural change?

24

Final thought

Our project focus deflects from wider cultural question about financial services:

climates of insecurity, individualism, lack of organisational loyalty and trust; “bubble” lives cut off from friends; ethics framed narrowly as rediscovery of client

Perhaps this systemic cultural risk of financial services is obscured by efforts to improve risk culture?

25

Thank you

http://www.lse.ac.uk/researchAndExpertise/units/CARR/pdf/Final-Risk-Culture-Report.pdf

26