Fri, Jun 17, 2016

Eye on the Markets Summer 2016: Informal Business Culture in Financial Services: Does it Matter?

2015 was, again, a year of “first time cases” for enforcement actions with total fines amounting £6.2b across the FCA, CFTC, FINRA, SEC and SEC.
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The State of Play

Despite that enforcement actions further add to the cost pressures of financial services companies, they do not seem to be enough of a deterrent for avoiding non-compliant behaviors.

Meanwhile, to identify and prevent noncompliant behaviors, financial services companies continue to invest in data analytics-driven compliance and risk frameworks. In addition, firms continue to implement business culture change programs, as the role they play in noncompliant behaviors has been widely acknowledged, especially following the Saltz Review in 2013. However, critics argue that business culture transformation programs are mere window-dressing techniques.

Whilst these above-mentioned actions are necessary, they fail to act upon one of the industry’s invisible challenges, namely informal business culture. As a consequence, compliance and risk frameworks, alongside business culture transformation programs, will continue to be sub-optimal if they are overshadowed by strong formal-informal business culture asymmetries.

Informal Business Culture: Why it Matters?

Informal business culture is the set of organizational characteristics and relationships that are hidden but powerful as they informally reinforce certain values and behaviors. When the asymmetry between the formal and informal business culture is strong, agents tend to revert to the informal business culture for informing their behaviors

Informal business culture can contribute to nurturing behavioral biases. For example, if the informal business culture over-emphasizes top performance, agents will face self-worth stresses that lead to rationalization, self-serving behaviors, alongside other biases. Ultimately, these biases will be driving the agent away from cultivating one of the key factors for avoiding non-compliant behavior, namely critical judgement.

Informal business culture and subsequent behavioral biases can also contribute to nurturing unintended behavioral consequences. Partly the reason why compliance and risk frameworks are not working is because they are distorting the decision-making process. Therefore, behaviors intended to outsmart the system are encouraged. In addition, compliance and risk frameworks can also create a perception of safe-harbor whereby agents tend to shift their responsibility, with regard to compliant behavior, by thinking that “it is someone else’s job”.

Informal Business Culture: How to Fix It?

To achieve a sustainable change in business culture, the formal-informal business culture asymmetry must be tackled. For this purpose, in broad brush, a three-stage plan is necessary:

  1. Diagnostic Stage: (i) develop and update, through machine-learning algorithms, an informal business culture database and (ii) develop a formal-informal business culture asymmetry map.
  2. Awareness Stage: (i) communicate the features of the informal business culture and (ii) raise awareness about the consequences of informal business culture.
  3. Reconciliation Stage: (i) develop behavioural de-biasing techniques and tools to reduce the formal-informal business culture asymmetry and (ii) institutionalise the formal-informal business culture symmetry as part of the day-to-day work.

The question of non-compliant behavior within the financial services industry is complex and reducing the formal-informal business culture asymmetry is one factor for preventing non-compliant behavior to arise in the future. However, it is an important factor to act upon.

An expanded version of this question will be presented by Alexandra at the 6th International Disaster and Risk Conference IDRC Davos 2016, the world’s leading conference on Integrative Disaster and Risk Management, of which patronage includes international organizations, such as the Organization for Economic Co-operation and Development (OECD) and the United Nations (UN), as well as private sector organizations.

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