At conferences in Sydney last week, the heads of ASIC (Greg Medcraft) and APRA (Wayne Byres) agreed on a few things: banking culture is rotten; culture is “hard” to deal with; and regulators are basically at a loss on what to do about it. Medcraft said:
“When culture is rotten it often is ordinary Australians who lose their money. And that is my point – markets might recover but often people do not. So that is why we need to clean up culture because people suffer. And people are sick of it. They want to have trust and confidence in the institutions they are dealing with.”
Medcraft wants to be able to criminally charge banks and their directors when company culture has allowed for staff misconduct.
Medcraft’s outrage disguises the fact that Australia’s regulators may have had something to do with fostering a “rotten” banking culture. For example, when the Four Pillars were fined some A$1.7 billion and censured by the New Zealand High Court for Tax Avoidance neither regulator censured the boards or senior management of four banks, or even commented at the time on the cultural messages such behaviour would inevitably reinforce.
To give ASIC credit, in another speech last week Commissioner Greg Tanzer outlined a very long laundry list of things ASIC is now going to look at relating to culture, including: reward structures; whistleblowing policies; conflicts of interest; complaints handling; and corporate governance.
The regulators might wish to look the latest research showing the avoidance culture behind the risk taking by Australian bankers.
Or the experience overseas showing the difficulties of actually changing banking culture.
But the problem is wider than individual banks and includes the culture of the banking and regulatory system itself.
A system beset by groupthink
While Australian regulators bemoan the industry’s culture problem, the Irish parliament is holding yet another inquiry into the tragedy that beset the Irish banking system before the global financial crisis. Irish finance leaders have fronted the inquiry, singing from the same songbook. From bankers, regulators, auditors, the media, to academics, commentators and managers of construction companies, (almost) all were repeating the same thing – ‘No one - but no one - saw it coming’.
There were a few exceptions who had been off-key before the crisis, including Professor Morgan Kelly and a brave regulator, Con Horan, who had warned of the impending calamity but was told not to rock the boat. Aside from those notable exceptions, everyone else appeared to be on same page.
In behavioural economics, such “concurrence” across a group is called groupthink. Everyone in Ireland, or at least those in charge of the financial system, believed the economy would keep growing forever. And why not, as Ireland was in the midst of a 25-year boom - sound familiar?
Groupthink (or more properly in this case “systemsthink” because the whole system was deluded) is unhealthy because, not only do people start to think alike, it is only a short step to believing people who are singing a different tune should be excluded and thrown out of the chorus. Dissent can be destructive, but the role of the Devil’s Advocate is well-understood to be valuable, drawing out important questions people would rather not answer.
But it’s not only in Ireland that people are afraid of rocking the boat. In Senate hearings this week into high credit card interest charges, RBA Assistant Governor Malcolm Edey admitted the Reserve and Treasury were aware of the problem, but said it was not up to them to question Australia’s banks on card rates. He recommended ASIC or APRA be the people to ask, if one was really worried. Since the RBA, APRA, ASIC and the Treasury are the four members of the Council of Financial Regulators (CFR), one would have thought that one of their regular meetings would have been an ideal opportunity to bring this issue up – but no one did.
It is the primary role of Australia’s banking regulators to promote systemic stability. But what if the whole system, including banking regulation, is deluded (as happened in Ireland)?
So how could a Devil’s Advocate be introduced into the regulatory process? The recent Murray Inquiry into the Financial System made one recommendation that could help. The inquiry recommended the establishment of a new Financial Regulator Assessment Board (FRAB), which would be asked to “assess how regulators have used the powers and discretions available to them”.
The Murray inquiry envisaged that this new board would consist of knowledgeable experts, crucially not tied to regulators, with a diverse membership that would “act as a safeguard against the FRAB being unduly influenced by the views of one particular group or industry sector”. The Inquiry also recommended that FRAB’s assessments of regulators should be made public. The creation of the FRAB is awaiting the government’s response to the Murray proposals.
Experts, such as Dr Andy Schmulow, suggest the FRAB proposal may however be dead on arrival, due to push-back from regulators. That is a pity, as regulators should welcome the creation of such an independent body, even though they know it may cause them some uncomfortable moments along the way. Constructive questioning of perceived wisdom will enhance rather than reduce systemic stability, which is after all the goal of banking regulation.