This is why conduct and culture form spearheads of DNB’s supervision for 2011. The initial results of an examination into decision-making at financial institutions are expected in the course of this year.
The recent advertising campaigns are illustrative of the changed tone of voice adopted by the financial world following the credit crisis. In the past, financial institutions promised a grand and compelling life, now they try and present themselves more and more as sound and reliable. It is a logical response to the sharp decline in public confidence in the financial sector, its directors and their motives. The tide must be turned; the financial sector must regain the trust of the general public.
In April 2009, the Maas Committee took the initiative. In order to win back the sorely needed trust, the Committee urges banks to put the customer first. To do so, the Committee makes a whole range of recommendations. Just as banks, supervisors must also draw lessons. If the supervisor only looks at an institution’s solvency and liquidity, it may become blind to the risks ensuing from conduct and culture. An institution’s financial figures may suggest that 'the sky is deep blue,' whereas its culture and conduct may pose risks for its long-term viability. For instance, unbalanced decision-making may lead to wrong or rash choices, which in turn could undermine an institution’s solidity.
New centre of expertise
DNB’s priority lies with an intensification of prudential supervision of the conduct and culture of financial institutions. This goes hand in hand with other innovations in supervision, such as the introduction of the new supervisory frameworks Basel III and Solvency II and the reinforcement of macroprudential supervision. It is of great importance to DNB to gain better insight into conduct and culture and any potential risks. For this purpose, this year’s examinations focus on aspects such as remuneration, board effectiveness and balanced and consistent decision-making. In order to give this supervision of conduct and culture more substance, a new centre of expertise was set up, the Expert Centre on Culture, Organisation and Integrity (COI). The experts develop new supervisory methods and give advice on difficult cases. They are also involved in assessing directors’ expertise. This initiative to supervise the conduct and culture of institutions puts DNB at the front of international supervision.
Decision-making in the spotlight
The first examination project has been started to test balance and consistency of the decision-making process at financial institutions. These two elements were also published in DNB’s policy vision 'The Seven Elements of an Ethical Culture', which forms the basis for supervision of conduct and culture. DNB conducts this examination at eight financial institutions, not only banks, but also insurers and pension funds. The examiners zoom in on several important decisions taken by institutions. Examples are product introductions, investments and organisational changes. Was the decision-making in these cases driven by more than just the financial consequences? Did it also consider the impact on employees, customers and other stakeholders? These are issues the examiners will be focusing on. They will check to what extent institutions comply with their own procedures and whether the checks and balances operate adequately in practice. Other points for attention are the transparency of decision-making and the exemplary behaviour of directors, the tone at the top. DNB will discuss the results of this examination with the relevant institutions before publishing the general findings.
Using the most recent insights from academic research and experience, DNB can further develop its supervision of conduct and culture. The guideline is an overview of conduct and cultural risks for financial institutions. The supervisor zooms in on those risks that could sooner or later undermine the stability of the institution. Examples are groupthink and narcissistic leadership. Groupthink is a classic example of risky conduct, in which the drive for unity and harmony within the group may come at the expense of critical discussions. In the worst case scenario, the group may feel invincible, causing its infinite overestimation to encourage greater risk-taking. And as the group members always agree and never hear a dissenting opinion, they are also convinced that they are morally the best. Another conduct risk profile is that of the narcissistic leader. A narcissist does not leave room for input – let alone criticism – from others, and this leads to risky behaviour. But if the narcissist is in the company of those who dare contradict him, the risks are considerably reduced.
The testing and assessment of the conduct and culture of an institution's board and of the entire organisation is new and partly unexplored territory. However, this should not prevent supervisors from looking beyond the financial figures. After all, problems in the culture or conduct of an institution may eventually impact the institution, its customers, employees and other stakeholders.This calls for preventive examination, because the supervisor wishes to see potential thunderclouds arrive before they burst out.