Bank Culture Reform – Our Next Steps
16 Jan 2019
Bank Culture Reform – Our Next Steps
Alan Au, Executive Director (Banking Conduct), Hong Kong Monetary Authority
(Regulatory Keynote Address at 1LoD Summit in Hong Kong)
John (Baskott), distinguished guests, ladies and gentlemen,
- Good morning to all of you, and for those travelling to Hong Kong for the Summit today, my very warm welcome to you all. I am very pleased to be invited to join you today at the Summit.
- When I received the invitation a couple of months ago, I was very impressed by the name of the organiser “1LoD” – or the “1st Line of Defence” and that it was trying to organise the Summit in Hong Kong after the successful events in London and New York. The 1st line of defence is very important, and perhaps the most important in the control framework of financial institutions.
- As all of you have made the effort to come to the event today, I think you would all agree with me that culture is important, especially for the 1st line of defence, and it is not something new. Regulators around the world have been driving sound bank culture, and different jurisdictions may be adopting different approaches.
Trilogy of Sound Banking – Hong Kong context
- Before I talk about our work in the Hong Kong Monetary Authority in driving bank culture reform, I think it would be useful for me to start by sharing our philosophy and motivation for promoting sound culture in the banking industry. As Hong Kong is an international financial centre in Asia, I would like to link the subject of bank culture to some long existed traditional Chinese wisdom. For those of you who have studied the traditional Chinese ideologies, you may have heard about “Confucius”, “Legalism” and “Mencius”. But for the benefits of those who have not or may have forgotten, may I take a little bit of time to explain.
- At the risk of oversimplifying the philosophy of Confucianism (儒家), it emphasises personal morality and virtues. To the extreme, there may not be a need for rules if everyone in the world behaves to the highest standards themselves. On the other hand, the philosophy of Legalism (法家) emphasises law and administration. However, I think you would agree with me that either moral suasion or tight regulation alone is not going to deliver sound culture. In fact, this limitation was mentioned by Mencius (孟子) over two thousand years ago. Supplemented by a modern economic overlay by our Chief Executive Norman Chan, we may say that “virtue alone is not sufficient for the exercise of government; laws alone cannot carry themselves into practice; profit maximisation alone is not sustainable in the long run” (in Chinese: “徒善不足以為政；徒法不能以自行；徒利不可以為繼”).
- So let me link these ideologies back to the relevance to sound bank culture. It points to the three elements or levels. First, robust regulation and supervision will set the minimum standards for compliance and will be the most effective in prescribing what constitutes unacceptable behaviours or outcomes. However, it is much less effective in promoting good or best practices and driving good corporate culture. Secondly, right values and ethics must be in place to guide the mindsets and behaviours of management and staff of banks. A bank and its staff must internalise good culture and values in such a way that they behave properly not because they are afraid of being caught and punished, but because they think it is unethical to do otherwise. Thirdly, good corporate culture must be underpinned by an appropriate incentive or compensation system across the entire bank at all levels to induce proper behaviour, which helps restore a strong alignment of interest between bankers and their customers.
HKMA’s Bank Culture Reform
- Since the Global Financial Crisis, supervisors and senior management of banks globally have made considerable efforts to enhance standards and practices regarding the governance and risk management framework in banks. However, although efforts have been made to promote a proper culture, misconduct cases involving undesirable behaviour of staff leading to poor customer outcome continued to happen. It was on this basis that the HKMA launched our “Bank Culture Reform” in March 2017 with a view to cultivating the right culture and values in banks. While there is no one-size-fits-all approach when it comes to culture, we ask banks to adopt a holistic and effective framework for fostering a sound culture, and give particular attention to three pillars.
- The first pillar is “governance” – culture defines ethical values and acceptable behavior within the bank that must be set and owned by the board and senior management and supported by sound governance framework. The second pillar is “incentive systems” – the ethical values and acceptable behavior must be underpinned by appropriate incentive system that induces the desired behaviours at all levels. The third pillar is “assessment and feedback mechanisms” – an effective feedback loop on actual outcomes should be put in place to inform the culture journey.
- The HKMA has provided practical guidance on these three pillars to all banks through an important circular in 2017. On the first pillar of “governance”, we ask banks to set up a board-level committee, chaired by an independent non-executive director, to advise and assist the board in discharging its responsibilities for the bank’s culture-related matters. On the second pillar of “incentive systems”, we are not just referring to remuneration. It is a much wider concept, as it also includes staff recruitment, performance assessment and promotion systems. We ask banks to avoid using a quantitative, formula-based target (such as sales or profits target) as the sole or primary determinant of staff performance and remuneration so as to avoid incentivising short term business performance at the expense of customer interests. On the third pillar of “assessmentand feedback mechanisms”, we are looking for “echo from the bottom” besides “tone from the top”. We ask banks to put in place an effective feedback loop to solicit response from their staff and customers, as well as an effective escalation policy (including “whistle-blowing” mechanism) to allow staff to timely report any illegal, unethical or questionable practices in a confidential setting so that there is no fear of reprisals.
- Why do we ask banks to pay attention to these three pillars? From our supervisory experience, we often found that the root causes behind major conduct incidents often relate to a combination of these three pillars. Let me share an example with all of you. An example is mis-selling of accumulators. Some private banks failed to explain to customers the key features and risks of accumulators, such as the worst case scenarios and margin requirements. Some sales staff solicited customers to enter into new accumulator contracts, albeit the customers’ exposures have already exceeded the concentration thresholds. These cases showed that the banks concerned, especially their 1st line, failed to put the interests of customers at the centre stage in the pursuit of commercial interests. The malpractices were not identified nor escalated by any staff. This reflected a combination of issues in all three pillars, including potential weaknesses in internal monitoring; over-reliance on sales target in performance measurement; as well as ineffective feedback mechanism.
Progress so far
- So how banks are progressing so far in their bank culture reform journey? It is definitely a long battle and too early to claim success. Nonetheless, it is encouraging to see that some banks have taken initiatives to promote sound culture according to the three pillars. We would like to share with you some of our early observations.
- Under the pillar “governance”, an example is that a foreign bank branch of a global systemically important bank in Hong Kong conducted a “Culture of Integrity Workshop”, which was hosted by a member of the bank’s Global Board. Prior to the workshop, bank staff were asked to contribute real-life conduct scenarios they faced which they felt were grey areas on integrity. During the workshop, discussions were held on the top 10 situations requiring further guidance. An example of these situations includes a client calling to execute a very profitable trade yet the KYC/AML approval is still pending. As compared to the bank’s traditional on-line learning of the Code of Conduct, this kind of workshop would be more effective in encouraging senior management to act as role models to demonstrate how to apply the Code of Conduct in practice.
- Under the pillar “incentive systems”, it is encouraging to see that a bank proactively reviewed its incentive systems of sales staff, following a misconduct incident relating to sales of unsecured personal loans. One of the recommendations arising from the review is that the percentage of variable pay of the sales incentive should be reduced, and that the bank should allocate higher weighting on non-financial metrics, such as those related to culture and conduct, in the performance assessment.
- Under the pillar “assessment and feedback mechanism”, it is a good starting point that a bank has developed a bank-wide Cultural Dashboard for reporting to the bank’s senior management and its board-level committee responsible for culture-related matters. And the bank has also strengthened its internal promotion on whistle-blowing mechanism by reiterating its commitment in fostering an environment that protects and supports employees to speak up.
Our Next Steps
- Ladies and gentlemen, these are only some of our early observations so far, and we believe the momentum is building up. Nonetheless, we have always looked at Bank Culture Reform as an on-going journey and we well understand that results cannot be achieved overnight. We aim for continuous effort and sustainable improvement.
- It has been nearly two years since we issued the circular. So, what will HKMA do next? The next steps would be to see banks’ progress in driving bank culture reform. While banks have implemented initiatives to enhance their bank culture, there needs to be some way to see if the initiatives are effective in driving culture reform and whether we need to provide further guidance to the industry. To take the matter forward, the HKMA has just launched three culture supervision initiatives as promulgated in a circular to banks in December 2018.
- The first initiative is self-assessments by banks: Banks are required to review and report their governance arrangements as well as policies and procedures in relation to corporate culture, and their implementation of enhancement measures in fostering a sound bank culture with respect to our circular in March 2017. We would first start the self-assessment exercise, covering about 30 banks including all major retail banks and selected foreign bank branches with substantial operations in Hong Kong. Those banks not selected in the first phase will still be expected to reflect on their own cultural enhancement initiatives, including lessons learnt. We do not want the self-assessment to become a compliance check-box exercise. Hence, we have designed a two-part template for the self-assessment. The first part “Culture Questions to the Board” comprises a set of high-level questions, aiming to serve as an opportunity for the banks’ board to reflect on any insights, lessons learnt and issues encountered. The second part of the template consists of specific questions for banks to assess the implementation of the enhancement measures with respect to the circular we issued in March 2017.
- The second initiative is conducting focus reviews: The HKMA will, through site visits and/or off-site reviews, assess and benchmark banks’ practices with respect to key areas of bank culture. We will make reference to the self-assessment by banks as the basis in identifying the priority areas for conducting the focus reviews. A possible topic would be the incentive system of front offices in specific business streams of banks (including the use of quantitative and qualitative performance indicators, and the use of financial and non-financial rewards). We aim to share our observations as well as the good or bad practices identified in the focus reviews with the industry.
- The third initiative is culture dialogues with banks: The HKMA will meet with senior management and/or board members of banks responsible for culture, including but not limited to chief executives and other members of the senior management team, as well as independent non-executive directors and members of the dedicated board-level committee responsible for culture-related matters. During the culture dialogues, we will have a more in-depth discussion with banks on the effectiveness of their culture enhancement measures. It is also meant to provide an opportunity for banks to showcase their work in driving culture reform and reflect on any issues encountered in the implementation of culture enhancements.
- Ladies and gentlemen, promotion of sound bank culture is a huge and important task that requires collaborative efforts of the industry and the regulator. At this juncture, we are still at the start of an on-going journey of culture reform on which the HKMA would continue to work with the industry.
- I would like to thank 1LoD again for inviting me here today. I hope that my sharing, as well as today’s fruitful programme at this summit, would be helpful to all of us as we move along the bank culture reform journey.
- Thank you very much.