Is culture a leading indicator of risk-taking behavior in banks?
Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB recently unpacked the ECB’s philosophy on supervising a bank’s culture and its importance. A fundamental pillar and driver for supervising culture is the argument culture can’t be seen but is expressed visibly through behavior. This means that culture is the “invisible hand” that can steer employees towards reckless actions; or prudency.
A deep dive into the recently failed bank, SVB, showed that the bank became entangled in the tech venture community and that this high-risk culture started seeping into its own operations – to the point that an employee was quoted saying: “Working at SVB felt more like working at a tech company than it did like working at a bank”. SVB had an aggressive growth strategy and grew rapidly during the pandemic. It invested customer deposits in long-dated securities to boost its profitability however this made it vulnerable to rising interest rates. In his testimony to the U.S. House of Representatives, Fed Vice Chairman Michael Barr stated "SVB failed because the bank's management did not effectively manage its interest rate and liquidity risk, and the bank then suffered a devastating and unexpected run by its uninsured depositors in a period of less than 24 hours". This risk-taking behavior was accepted in a culture that was closely emulating that of its risk-seeking clients – creating a strong case for the importance of culture.
California-based Silicon Valley Bank (SVB) was shut down by the state's banking regulators on 10 March after a sharp drop in deposits.
But what empowers culture change? Bryan Walker, Partner and Managing Director at IDEO San Francisco, and Sarah Soule, the Morgridge Professor of Organizational Behavior at Stanford University, have isolated five key practices:
Positioning of the problem (or opportunity) so that employees feel a deep pull and need to change.
Harnessing the power of quick wins to create opportunities for celebration and draw in those who have not yet committed to the movement.
Leverage network nodes to bring scattered communities closer to the change being advocated.
Provide the space for those who have bought into this change to take action without the dominant culture extinguishing early gains.
Create mechanisms to visually identify solidarity. An idea as simple as matching t-shirts can help bolster change by creating stronger social networks with like-minded employees.
It doesn’t mean that creating the right culture in banks isn’t tricky. Banks need to be innovative to compete, however, the culture of innovation needs to be balanced with one of prudent risk management that ensures the safety and soundness of the bank. The pressure to innovate has never been higher with banks needing to respond to new disruptive technologies, competitive threats from FinTechs, emerging risks, and new regulatory requirements.
The rise of Embedded Finance is a case in point that is forcing banks to rethink their business models and to do that, banks need a culture that supports evolution within clear risk guardrails.
In eliciting any cultural change banks need to remain vigilant of their risk culture and whether its governance and oversight structures produce the desired risk behaviors. This includes ensuring employees are aware of the risks they take to achieve their objectives, whether it is within the risk appetite set by the bank, their adherence to policies and procedures, and whether their incentive structures are aligned with the desired outcomes. All of this needs to be reinforced and supported by a strong "tone at the top" that emphasizes responsible risk-taking behavior and decision-making that encourages diverse perspectives and constructive challenges.