Supervisors on Supervision

“During the Financial Crisis, the Senior Supervisors Group (SSG) did a deep dive on what the failings in risk management were that led to how we got where we did. Their first report on the Great Financial Crisis was published in late 2009.

And the SSG continued throughout my tenure because it was an opportunity to bring together the actual supervisors — people who ran supervision — as opposed to those who developed policy, who often weren’t actual supervisors executing supervision. 

So the SSG got together and was able to actually talk about real supervision issues, culture supervision being one of the topics. That was one of the opportunities that folks had to learn about what the DNB was doing and then share with each other what they were doing on culture. One of the benefits of these international groups is you get to hear what others are doing.”

“[G]iven some of the lessons learned from [pandemic] WFH experiences, it would be worth exploring more to understand what parts of the supervisory process worked well in a remote setting and which parts were less effective.

As a start, where firms already had an established relationship with their exam teams, including a regular cadence of interactions, that foundation was critical in ensuring an ongoing productive dialogue, even when those conversations moved to an entirely virtual setting. Establishing and maintaining trust, which is foundational in the supervisory context, is very difficult in an entirely virtual environment — and even more so when you’ve never met the other person live.

Also, there are things that are missed in an entirely virtual environment — like the cues in meetings that you don’t pick up in the gallery view, the pre-meeting ‘get to know you’ portion of the engagement, body language that sometimes reveals other things (like, discomfort with the information being conveyed, or lack of understanding of the answers provided). These ‘misses’ go both ways in the supervisory relationship and often can be picked up and remedied more quickly in a live setting.

We need to consider whether culture was robust or resilient to the changes driven by the pandemic, including the changes in how, where, and when we worked. And how ‘speaking up’ and ‘say something when you see something’ works in a virtual environment. How does challenge, or ‘speaking up,’ work when you aren’t in person? I’m not sure we have an adequate understanding of such risk management issues as yet.”

“Different firms will have different cultures. It’s critical to know what culture you have — and want to have — and to design how you work around that. Also, it is important to know your employees and prospective employees and to develop an informed sense of how they work with and react to changes in their day-to-day work environment. Who do we want to recruit, going forward? We need to be deliberate about setting our work environments and about our expectations for how people will work within a firm.”

“The events of the 2008 Financial Crisis, together with several scandals that followed, made it clear that more work was needed to address some of the underlying issues that led to these events. [The Federal Reserve Bank of New York] wanted to understand better what the drivers were — and wanted to work with the industry, academics, and others to take a closer look at culture as a potential driver of conduct within financial services. This led to the first of a series of conferences hosted by the Federal Reserve Bank of New York, starting in 2014. 

This effort has now grown into the ‘Governance and Culture Reform’ initiative — a multi pronged approach that incorporates educational and training efforts, direct dialogue with the industry, and sharing of best practices across regulatory agencies, combined with the more public events like conferences, podcasts, etc.”

“While lots of bad things happened during the Financial Crisis, everybody was so focused on fixing it that I don't think there was much time spent reflecting on it. The real trigger point came later with the FX and LIBOR situations. 

I know in conversations, we looked at each other and said, ‘WTF? We just went through a terrible crisis, and now we have these issues?’ For me, that was the moment that prompted a lot of the effort to think about what was actually driving this behavior. 

People started talking about ‘bad apples’ and ‘broken windows,’ and the issue started to get some momentum, particularly at the New York Fed. We tried to explore what this meant, what it was, and what should be done. I think there were even some efforts coming out of the initial set of conferences [organized by the NY Fed] that were supposed to bring together the private and public sectors on things like the whole mortgage process, asking, ‘Is there a different way to actually do this?’”

“The challenge was that, when you talked about culture, not everyone we spoke with understood what culture was or what we were referring to. And many didn't believe culture was a thing. Then you had some policymakers in the U.S. who were either uninterested in the topic or didn’t think culture was a thing either. The resistance in the U.S. was immense, both at the official level and in the private sector. 

Some argued, ‘If you can't write a rule around it, it doesn't exist.’ So anything that we were going to be doing, anything that we were going to evaluate, they thought that you had to have a specific rule that could be written about it before we could do anything about it. 

We started to explore [culture supervision] and tried to initiate some pilots in New York using the techniques the Dutch central bank had used, but we weren’t able to get buy-in from policymakers in DC. They wanted us to ‘stay in our swim lane.’ 

Since we weren't able to use supervisory processes and tools, we then went into the culture initiative through other means outside of supervision. We could put on conferences, initiate work with academics, and make speeches about it, which a number of us did.”

“One of the areas where I think there’s an opportunity to advance our toolkit is through more forward-looking tools — those that allow firms to identify hotspots and take action to prevent future misconduct. 

While these efforts don’t replace the ongoing need to be able to detect misconduct (though that’s after it happens and has potentially already had some level of impact), there are opportunities to get in front for example, to look through vast amounts of data (structured and unstructured) and identify patterns of behavior that signal something is amiss in certain parts of the organization.

Can you imagine getting a report that says that one of your teams is an outlier on a particular dimension? How great would it be to be able to jump on that issue — before something even bigger occurs?”

“What's different, among the many things that are different today, is the idea that there are metrics and that there are things like AI that can do so much more than what we did last year, much less in 2012.”

“[O]ne area we should explore is operational resilience. As the pandemic unfolded, global regulators significantly increased their scrutiny of operational resilience. A next step would be to consider tools, like stress testing, that would allow for a more systematic assessment of operational resilience — and allow us to ‘test’ resilience across the different constituent elements beyond financial resilience — to include areas like operational resilience and organizational resilience. 

It’s this last piece — organizational resilience — where I see the opportunity to draw the linkage between operational and organizational resilience, and more specifically to conduct and culture — and to consider questions like:

• Is your organization — your workforce/your people — resilient to the next crisis? How will the organization react to the next event — and will your organization be able to ensure that critical operations and activities continue to run as expected?
• Is your culture strong enough to withstand the types of changes that could come in the next type of crisis? What are the critical aspects of your culture that ensure that your organization can adapt — and what are the ways that you can reinforce and build that now?

In the same way that regulators were able to identify weaknesses in financial resilience — both quantitatively and qualitatively — and ensure that financial capacity was reinforced to withstand the stresses over the past couple of years, now would be a good time to focus attention on a similar approach to non-financial risks (e.g., operational, operational resilience, etc.).“

“If something else happens that sends the financial industry into another crisis, that'll put things on pause, depending on what it is. But we don't need legislation to make this happen or to take on the kinds of actions that might be outlined for the future.”

“We became aware of the work that the De Nederlandsche Bank (DNB) had been doing. We thought, ‘This is interesting. We should learn more about this.’ So we spent time with [Mirea Raaijmakers] and others at the DNB learning about what they did and thinking through what we could do in New York that might look like that, because we thought there was real value there, there were real cultural issues. 

The thing about the DNB's approach was that it wasn't just a reaction to bad behavior; it was a disciplined approach. It didn't come across as crazy. It came across as well-studied and evidence-based. ‘Here is the reason to do this.’ ‘This is what we're looking at.’ It wasn't just made up.”

“When we explored doing cutlure reviews at the NY Fed, the banks were curious about running pilots. Many at the time dealing with scandals across FX, LIBOR, and other rate-rigging. So there was some level of curiosity about whether this kind of effort, either by the organization or by us, would have been able to identify those kinds of problems. 

I also think the organizations thought they had good cultures, so they believed this was going to validate something for them.”

“It feels like we've got to figure out where interests are aligned. That's where things like supervision actually tend to work — where you've got interests that really are aligned. And so it doesn't take a whole lot for the industry to say, ‘Holy crap, we do need to do that.’ 

It's the leadership. It's the right mix of leadership between the public, private, academic, and industry sectors. It’s having the courage and the wherewithal to push ahead. 

This requires the public and private sectors getting together, but somebody has got to be the leader. We tried a couple of times to get the banks to get together and figure this out. The UK did it with their banking conduct organization [FSCB], but nothing happened in the U.S.”