Tough new conduct risk rules are making it easier for UK regulators to spot evidence of cultural failings at banks, with repeat offenders likely to see their operational risk capital requirements hiked, the governor of the Bank of England, Mark Carney, has warned.
The Senior Managers Regime – which came into force for banks and prudentially regulated firms last year, and which is due to be expanded to include virtually all firms regulated by the Financial Conduct Authority next year – requires firms to clearly define responsibility for 17 key functions across an institution, such as the role of chief risk officer and head of anti-money laundering controls. It also includes basic requirements for institutions to act with integrity at all times and treat customers fairly.
“For supervisors – us and the FCA – the regime is helping identify weaknesses in governance and accountability. It’s helping us assess the fitness and propriety of senior managers and others in positions of responsibility – and [assess] whether a firm has the appropriate culture and is encouraging the necessary changes,” said Carney, who was speaking at an event held by the Ficc Market Standards Board in London on November 29.
“If that isn’t the case, in the first instance, widespread or consistent shortcomings would have consequences for the compensation of individuals. More persistent failings could increase the capital that is set aside for operational risk – so it would have consequences for the firm itself. And in the extreme, it could influence our judgements regarding the fitness and propriety of senior managers,” he added.
Carney did not offer an example of what persistent failings could look like – nor how an ad hoc add-on to a bank’s required minimum level of op risk capital would be applied. At present, the UK’s Prudential Regulation Authority uses supervisory judgement to determine how much Pillar 2A capital banks must put aside for conduct risk.
Under a BoE proposal issued in July, banks will also be expected to reveal their total capital requirements across Pillar 1 and 2A – something op risk practitioners say could end the current disparity in disclosures between banks using different approaches to calculate their op risk capital.
The Senior Managers Regime has been the subject of controversy since it was first mooted. Banks complained the pace at which the rules were introduced left them little time to root out bad behaviour; others have reported recruitment difficulties for key functions, as well as uncertainty over what breaches should trigger a disciplinary action. A controversial clause that would have placed the onus on senior managers to demonstrate they had taken all reasonable steps to prevent a bank failing, rather than the regulator having to prove the case, was watered down at the eleventh hour before the rules were implemented, after some fierce lobbying from senior bankers.
But Carney suggested the regime was welcomed by many senior managers for its positive impact on improving risk culture: “We are already seeing encouraging signs that it is making a difference. For firms, it’s clarified [the need for] improving governance, accountability and decision-making processes. Senior managers are increasingly focused on building cultures of risk awareness, openness and ethical behaviour. In the words of one chair, ‘Responsibility for culture has now moved to the top of my agenda’. I’m not sure where it was before that.”
Regulators’ standard response to cases of misconduct that have come to light post-crisis has been to levy large fines. These now total more than $320 billion worldwide, Carney noted – “capital that could otherwise have supported more than $5 trillion of finance to households and businesses across the G20”.
The impact of fines on banks’ capital requirements also lingers on long after the initial payments are made, as they have an outsize influence on the calculation of firms’ required levels of op risk capital.
Responding to questions, Carney suggested regulators increasingly prefer using enhanced governance and tougher conduct rules to tackle misconduct, rather than the big stick approach of fines.
“We all can sense that… an approach to misconduct which is entirely ex-post punishment of institutions and their shareholders at that time is not the best way to manage that situation,” he said.