Coda: Candid Reflections on the Culture Conversation
William C. Dudley, President
This is the final essay in a series leading up to Reforming Culture and Behavior in the Financial Services Industry: Progress, Challenges, and the Next Generation of Leaders, a conference the New York Fed is hosting on June 18.
It’s not unusual to be unusually candid on your last day of work.
Starting Monday, I’ll be the former President of the New York Fed. I like to think I’ve been candid throughout my 11 years at the Bank. But, just to be sure, I will not miss this last opportunity.
Monday also marks the New York Fed’s fourth culture conference in the last five years. Let me share a few lessons I’ve learned from these conferences.
Often people arrive with doubts about culture — “Why are we talking about this?” Skepticism is certainly welcome. And within these doubts there is usually a kernel of truth. To date, however, none of the doubts have convinced me that culture is not worth serious attention from the industry and the official sector.
Here are a few examples.
“Culture doesn’t matter. Only outcomes do.”
The truth is, a lot of things matter, not just culture. A firm’s capital and liquidity are essential to its ability to continue as a going concern. But it is misguided to argue that so long as a firm is well-capitalized and highly liquid, nothing else is important. For one thing, there’s technological change — the increased automation of decision-making and digitization of financial services. For another, there is competition for talent — how to attract and retain the right kind of financial professional. Neither of these issues factors into traditional notions of capital and liquidity. But no one would seriously argue that technology and the labor market do not affect the success and sustainability of financial services firms.
Moreover, a firm’s capital and liquidity — the bulwarks of its balance sheet — are managed by people. Smart, capable people, yes. But people nonetheless, fallible in the ways we all are. Human beings respond to social norms. Individually, there are times when each of us may go our own way. But not always. We all observe behaviors around us, see what succeeds and what does not, and to some extent adapt our own choices and conduct. Paying attention to culture does not mean ignoring other important aspects of financial services. It just means giving due attention to social norms that influence important choices that we make.
“Culture can’t be measured.”
The truth is, measurement is difficult. Discussions at our culture conferences have demonstrated, however, that there are many ways to assess an organization’s culture. There are quantitative measures, facilitated by advances in computer science and data analytics. There are also qualitative methods, most of which involve listening closely to and correlating feedback and multiple data points from private and public stakeholders. If you doubt the possibility or utility of measurement, I invite you to pay attention to the United Kingdom’s Banking Standards Board. They are very persuasive because they have the evidence to back up what they say. We will hear from them at Monday’s conference.
“Culture can’t be changed.”
The truth is, culture changes slowly. But there are very clear ways to change culture. One key is to create incentives for employees to act in ways that align with the private and public purposes of financial firms.
Hold the thought about incentives for just a moment, because the phrase “public purposes” doesn’t sit well with everyone. Financial firms are private enterprises, after all. They exist to deliver value to shareholders. They are not utilities. They have no public purposes except to follow the law — right?
That view is short-sighted. Banks in particular enjoy many public benefits — limited competition and deposit insurance, to name just two. In return, it is right to expect that they will meet basic public expectations — that they will be trustworthy. An expectation of trustworthiness also derives from the position of responsibility that banks hold by necessity. We expect trustworthy conduct from banks because they are so important to the nation’s economy.
There are, of course, many ways in which trustworthiness is mandated. Financial firms generally, and banks in particular, are highly regulated — much more so than many other industries. And, beyond particular regulation, we require that they submit to prudential supervision to promote confidence in their safety and soundness.
In short, there is a legitimate expectation that the financial services industry do more than follow the letter of the law. If you disagree, if you think that’s wrong, then the answer is more laws and regulation to give public expectations greater bite. That outcome may become necessary. But it is not optimal. Before going down that path, wouldn’t it be better for everyone if the industry tried to change its social norms to improve a public perception of trustworthiness?
Back to incentives. I believe to my core that culture (social norms) reflect behavior, and behavior is driven by incentives. If you want employees to behave in a certain way, you promote those who do and fire those who do not. In financial services, a field in which compensation is often highly variable, discretionary rewards must account for conduct as well as financial performance. I support the Group of Thirty’s previous recommendation for parity between conduct and returns. Under that model, I doubt employees will diminish their drive for profits, and fully expect that they will pay more attention to how they earn those profits.
The same holds for the timing of compensation. If you want employees to think about the long-term consequences of their decisions, don’t pay them exclusively in the short term. If compensation is spread out over several years — as in the performance bond program I have recommended for several years — employees will have good reason to think about whether their choices are sustainable. That will contribute to social norms that emphasize the long-term. Those norms will, in turn, make it easier to make choices that favor long-term sustainability in the next instance — a virtuous circle.
Beyond pay and promotion, here are some other ways firms can change their culture.
Hiring. Annual turnover at large financial firms is significant. That means every year there is significant opportunity to recruit people who support the firm’s values as they are publicly stated. Recruiting literature, processes, and practices should consistently promote those values, and should emphasize that success depends on adhering to them. There should be no doubt about where the firm stands on matters of principle.
Leading by example. If you want employees to behave according to principles, show them how. Firms whose leaders mention the organization’s values once a year, or who do not take the time to explain their decisions, will be more likely to have employees who consider the firm’s principles infrequently and who lack guidance on making difficult choices. By contrast, firms whose leaders take the time to emphasize the importance of choices that align with principles, and who demonstrate that type of integrity by their own behavior, will enjoy more consistent and better outcomes.
Education. Behavioral science has advanced significantly since many of us were in school, and much of what has been learned is not exactly intuitive. It is important that firms invest time in educating their senior leaders — the top 100 or 200 managers in the company — about behavior. The top managers of an organization need to think about how to present choices and create systems more likely to yield good outcomes. Behavioral science may offer helpful insights.
“Culture can’t be supervised.”
The truth is, firms are responsible for their cultures, not supervisors. It is also true that culture has many inputs, many of which are beyond the scope of supervision. And we each belong to many cultures. We are part of not just a firm, but of the teams, desks, and divisions that make up the firm. Many of us are part of professions as well, which have their own norms and independent governance. We are part of families, communities, faiths, and political organizations that also influence our behavior.
This all underscores that culture is complex. Even so, I believe supervisors have a lot to offer. They can hold up a mirror to banks about decisions and conduct. They have the benefit of horizontal insight from peer institutions. They compare notes with counterparts from other countries. And they draw from an array of disciplines — increasingly from behavioral and applied sciences, in addition to the traditional fields of law and economics. They offer what Gillian Tett of the Financial Times has called the insider/outsider perspective that is foundational in the field of anthropology. In short, they have a lot to offer to firms who are interested in understanding the social norms within their organizations.
To sum up, the overarching lesson of four years of culture conferences is the following: Culture matters. Change is possible, but difficult. It’s better to pay attention sooner than later.