Culture easy, but wrong, culprit in banking royal commission

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Published by Australian Financial Review, Wednesday 6 December

Much of the current debate about bank culture focuses on the remuneration and incentive systems. This is largely misplaced. Big banks have multiple cultures and those cultures are shaped by a variety of forces. Incentives might be one, but there are other larger forces at play.

A lot of the issues at the Commonwealth Bank, for example, have occurred in its wealth management division Colonial First State. People tend to forget that Colonial had grown aggressively during the 1990s under Peter Smedley, taking advantage of the rapidly growing superannuation pool through a series of takeovers.

Colonial’s culture was inevitably very different from the CBA which was emerging from its public service origins. The challenge for CBA management was how to continue to grow Colonial’s funds and profits while shifting the cultures closer together. The bank struggled to do this, and Colonial was never properly integrated. In this case the institutional history seems far more important than the remuneration structures in explaining cultural differences.

The case with Colonial and CBA raises the more fundamental issue of whether banking and wealth management can ever fit together or whether the cultures are inevitably so different that they are better in separate institutions. The evidence here seems to be that there is no fundamental conflict. The famous Swiss banks, Credit Suisse and UBS, have long-run businesses which bring together wealth management and broader banking without fundamental conflicts. They have managed to integrate the two business lines. Their approach takes a rounded view of their clients, managing and protecting their overall wealth. This should be possible for our banks too. To the extent this has not been achieved it is a failure of management.

One company, many cultures

The other big cultural clash within banks is between the investment banking and markets divisions of banks and their retail arms. All banks manage the two divisions separately.

The cultural differences here are a result of the different business drivers. In institutional banking the big driver of outperformance lies in the creation of bespoke products. In retail banking the emphasis is on standardisation and scale.

Once a product is standardised, the profit gets squeezed by competition so that investment bankers are always looking for new products, and new angles to provide a special service to any particular customer set. The search for new products inevitably takes banks into the business margins be they around tax arbitrage, risk arbitrage, and appropriate sales. In these cases, management has to make hard decisions about what are appropriate sources of profit.

There are a number of cases over recent years where senior managers in banks made quite different decisions about investment products. Some banks pushed hard into the agricultural investment schemes, while others held back and ceded market share to their competitors. Clearly the laggards decided that products supporting aggressive tax minimisation involved reputation risks they were unwilling to take. Again, some banks were far more aggressive in selling CDOs and related profits in the late 2000s while others held back. The differences here also related to managers deciding that the products were probably not appropriate to their clients and held back.

Managers care about reputation risk

In my view, experience over the last decade has shown that senior bank management is actually very sensitive to reputation risk, and has been reluctant to push inappropriate products. Their banks have made less profit as a result. The idea that senior managers are motivated purely by profit, and by remuneration, is demonstratively false.

Big banks, like all large social institutions, have multiple cultures. This is normally resolved by separating the entity into divisions and managing them separately. This is a standard issue of corporate management. The idea that wealth management and retail banking do not belong in the same institution, or that banks should not undertake investment banking, seems wrong. Yes, they have different cultures, and operate in different regulatory environments, but the same applies to the divisions of BHP, IBM or GE. Divisions might be spun off because they fit better with other entities, or because they absorb too much management effort, but not simply because they require a different culture.

CEOs then try to overlay these divisional differences with broader cultural norms. ANZ under Mike Smith went through a major cultural pivot towards Asia, and has now jettisoned that, and is doing a new pivot in a drive to become a technology company. These are major transformations which require a lot of effort and careful integration. At CBA, Ralph Norris undertook a similar cultural experiment to get the bank to focus heavily on customer satisfaction: with a mix of cultural programs and financial incentives. Norris was successful, CBA became the leading major bank on externally measured customer satisfaction. The irony is that even a successful cultural journey has not protected Ian Narev from a series of customer challenges.

Organisation culture is important, but large organisations inevitably have multiple cultures. Some are the result of history as with the Colonial heritage at CBA. Many reflect the different needs of the different businesses – retail banking requires different skills and approaches to investment banking. They are not all the consequence of remuneration schemes, and not simply the consequence of pay. Good managers will often take decisions which reduce profit in the pursuit of broader institutional goals. Their job is to balance a wide array of factors of which immediate profit is just one