A Starling Insights Deeper Dive Report

Supervisors on Supervision

— Perspectives: Where Culture Meets Prudential Supervision —

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Poor culture within a financial institution may initially present as a conduct issue: think, for example, of Credit Suisse’s tax evasion activities or its surveillance of employees, or the mis-selling of Payment Protection Insurance by UK banks before the Global Financial Crisis. However, conduct issues are often lead indicators of fatal prudential failings — as they proved to be in those cases.

Culture manifests itself in whether the bank’s business model is excessively risky or questionably sustainable; whether its people are open and thoughtful, or arrogant and complacent; and whether it recognises the long-term purpose and outcomes it should deliver to the financial system or instead focusses solely on short-term profitability and personal compensation. The culture of a firm has direct implications for financial stability.

Prudential supervisors must therefore place the assessment of culture at the heart of their supervisory programmes, and must devise a reliable means by which to assess culture that is transparent and evidence-based. Of course, that requires the supervisor itself to manifest and exemplify a culture that is measurably sustainable, open, thoughtful and both purpose- and outcome-driven.

The current supervisory standards

The Basel Committee’s “Core Principles for effective banking supervision” (April 2024) mentions the word “culture” 12 times — more often than in any prior edition — so it seems clear that the Committee recognises the importance of a bank’s culture. 

These references to culture, however, are dispersed across multiple principles, without a central framework by which to address methodologies and metrics for supervising culture. The result is that supervisors are left to devise their own approaches, with uneven work programmes and varying results across different jurisdictions, which fails to deliver the core objective of the Basel standards: namely a consistent minimum baseline for the supervision of internationally active banks.

Moreover, every one of the mentions of “culture” in the Core Principles relates only to the culture of supervised banks, not that of the supervisor itself; and yet, the supervisor’s own culture is critical to the effectiveness of supervision. Cultural failings among supervisors were only too apparent in the supervision of Silicon Valley Bank and of Credit Suisse.

The opportunity

As comes through with near unison in the stocktake reported upon here, the necessary next step is not to prescribe a single approach to culture in supervision, but to begin assembling a common framework that integrates these scattered references into a practical, end-to-end approach. This framework should clarify how culture assessment fits into prudential objectives, what evidence supervisors should seek to collect, how that evidence can be reviewed for consistency, and how it may be fairly challenged when appropriate, to support due process and, thus, sustained legitimacy.

With such a framework established, supervisors can then turn the spotlight on themselves and consider how to provide assurance to their governing bodies and stakeholders that their own institutional culture is measurably sustainable, open, thoughtful and purpose- and outcome-driven. Again, this would serve the cause of sustained legitimacy and trustworthiness of these essential institutions and of those who inhabit them.

The desired end-result is a system of actions by the financial institution and its supervisor which moves us beyond remediating the symptoms of cultural failings to identifying and addressing the root causes demonstrably.

What the table shows

The table above sets out four cornerstones of a sound financial institution: a sustainable business model; assets of appropriate quality; adequate capital and liquidity; and sound governance and risk management. The table then illustrates how those cornerstones may be eroded by cultural failings within either the financial institution or its supervisor. 

• Having identified how these failings manifest, the table can be used prompt critical questions:
• How would we identify and measure the problem in each of these cases, before it develops into a prudential crisis?
• How would we relate those measurements to our overall assessment of culture?
• What remediating actions would we take to address the cultural root causes, rather than just addressing the symptoms?

What’s needed next?

Delivering on this ambition cannot be the task of supervisors alone. The development of a coherent framework for culture risk governance and supervision must be a shared endeavour between supervisors and the institutions they oversee.

Such collaboration is essential for three reasons. First, acceptance: banks are far more likely to engage constructively with standards they have helped shape. Second, expertise: firms live their own cultures daily and can offer insights that external observers cannot. And third, objectivity: each side can help the other to confront uncomfortable truths — supervisors about firms’ behaviours, and firms about the supervisory culture that influences them.

A joint approach of this kind would not dilute supervisory authority. Rather, it would strengthen legitimacy and make cultural assessment a practical, evidence-based component of prudential oversight.