Conduct: Just a buzzword or critical to risk management?

Culture and Conduct as a combined topic is not just important to regulators but also to banking leaders. The 2022 KPMG Banking CEO Survey revealed that internal unethical culture was the second highest risk CEOs surveyed were worried about, with 32% of the vote, behind only Credit Risk at 33%.

Setting the Stage

It is important to make some distinctions and clarify a few points. Culture and Conduct are closely linked. If Culture refers to the shared values, beliefs, and norms that shape an organization’s behaviour, Conduct refers to the actual behaviour demonstrated by employees within an organization. It can be thought of as an outcome of Culture, though it is necessary to state that an outcome is a result whereas values are the driver.

A strong and positive culture can promote ethical and responsible behaviour, while a weak culture can lead to Conduct issues such as misconduct, fraud, and non-compliance. This brings up an important distinction: There is good and bad Conduct. The latter is effectively what we think would lead to Conduct risk i.e. the risk of financial or reputational loss resulting from actions of misconduct or poor conduct decisions.

Although most banks and financial institutions focus on mitigating bad conduct, promoting good conduct is equally crucial. Why? While poor Conduct may result in immediate negative consequences, such as regulatory fines or legal sanctions, good Conduct can help prevent and mitigate future risks. It is a long-term play with an emphasis on sustainable and successful business to help build trust and confidence.

Moreover, poor Conduct has been a focal point for regulators and institutions for some time with mixed results. It is time to apply a lens to and promote good Conduct to shift the mindset. A helpful analogy is the focus on prevention instead of the cure. Finally, human behaviour dictates that what gets rewarded or recognised, gets repeated.

How can we improve?

It is necessary to therefore have a balanced approach of mitigating poor/bad Conduct and promoting good Conduct. This will ultimately reap rewards in the medium to long-term, helping to manage Conduct risk in the process.

The real opportunity to improve Conduct risk management in banking or other industries lies in technology. Technology has the potential to revolutionize the way we think about Conduct, making it easier to track, measure, and improve. For example, Conduct monitoring software can be used to analyse transactions in real-time, flagging any suspicious activity and helping to identify potential Conduct breaches before they occur.

Artificial intelligence and machine learning can also be used to monitor conduct risk in real time to identify patterns of behaviour that may indicate poor Conduct, allowing financial institutions to take corrective action before it’s too late.   These insights can be used to develop targeted training programmes. (Source: Financial Stability Oversight Council. (2021). “Annual Report to Congress.”)

And with the rise of blockchain technology, Conduct can be even more transparent and accountable, providing customers with a level of trust and confidence that was previously impossible. But technology alone is not enough.

Improving Conduct in banking requires a cultural shift, one that starts at the top and permeates throughout the entire organization. It requires a commitment to doing the right thing, even when it’s not the easiest thing to do. How do we achieve that?

• Emphasizing a strong corporate culture: A strong corporate culture that prioritizes ethical behaviour and leadership can help to minimize conduct risk. This approach involves promoting a culture of honesty, transparency, and accountability. Conduct needs to feature in performance metrics and scorecards and good Conduct needs to be recognised, celebrated, rewarded and incentivised where possible. Research has shown that organizations with strong corporate cultures are less likely to experience misconduct. (Source: Gormley, T. A., & Matsa, D. A. (2020). “A Roadmap for Preventing Misconduct in Financial Institutions.” Journal of Economic Perspectives, 34(1), 61-86.)
• Hiring the right people: This may seem intuitive but there have been countless examples of individuals being recruited who, in practice and performance history, do not display the right values and behaviours. I don’t wish to specify names but a simple search will show that individuals with questionable reputations and work history have left a position with a failed bank only to appear at another failed bank. The merry-go-round needs to stop.
• Implementing a robust risk management framework: A comprehensive risk management framework can help to identify and mitigate conduct risk. This approach involves identifying potential sources of misconduct and implementing controls to prevent it. Moreover, a clear articulation of Conduct risk, where it sits within the risk taxonomy, how it is measured and clarification that it is the responsibility of all employees across an institution is critical.
• Utilising behavioural science techniques: Behavioural science techniques have been used to better understand the reasons behind misconduct and develop effective interventions to prevent it. For instance, the use of “nudges” can encourage employees to make better decisions by subtly altering the way that information is presented to them. (Source: Haldane, A. G. (2019). “The dog and the frisbee.” Speech given at the Federal Reserve Bank of Kansas City’s 43rd Annual Economic Policy Symposium.)
• Training and Development Programmes: Effective training and development programs can be a key driver of positive Conduct within an organization. By providing employees with the tools and knowledge they need to do their jobs effectively, banks can help to ensure that Conduct is prioritized and that employees understand the importance of doing the right thing. Here it is also critical to have a consistent feedback loop from the lessons learned, behaviours displayed and possible case studies witnessed when performing the Conduct risk monitoring and control work e.g. AI, technology, breaches etc. mentioned above. Measuring the effectiveness of these programs can be done through employee feedback and assessment of changes in Conduct behaviour.

Conclusion

Conduct is not just a moral imperative; it is a business imperative and is critical to comprehensive risk management. It is what separates the best from the rest and creates a foundation of trust between financial institutions and their customers.

We need to focus on both good and bad Conduct. Promote the former and mitigate the latter. By setting up the right frameworks, leveraging technology, implementing a continuous feedback loop, and creating a culture of transparency and accountability, we can continue to improve Conduct in banking & financial services and build a better financial future.

Ghassan Zeidan, Founder & CEO of Paragon Consulting Partners

linkedin.com/in/ghassan-zeidan

Risk Management, Internal Audit and ESG Consulting Firm (paragonconsulting.partners)