Banking’s Cultural Revolution

by Geoffrey Parsons Miller

Among the reforms emanating from the global financial crisis, few are as enticing as the idea of improving the culture of banking.

Nearly everyone agrees that there was something wrong with attitudes and behaviors in the financial services industry in the years before the crisis. Nearly everyone also endorses the proposition that inappropriate risk-taking and disdain for regulation contributed to the excesses characteristic of those years. And there’s broad consensus that a respectful attitude towards risk management and compliance can help protect against another crisis. There’s a lot of merit in these ideas.

But whenever one observes this sort of piling on, it’s useful to ask what we’re missing.

The principal force shaping culture in the banking industry is neither regulation, nor bureaucratic jawboning, nor sermons from CEOs. These do have an influence. But macroeconomic conditions are more important.

The irresponsibility displayed by bankers and regulators during the 2000s grew out of the easy money conditions of those times, just as the market turmoil associated with the bursting of the housing bubble in 2008 fueled the current enthusiasm for probity.

No one would suggest that a central bank should manipulate monetary policy in order to change bankers’ attitudes. But if monetary policy is the principal driver of banking culture, then other efforts at reform are likely to have less of an impact.

In the absence of unusual economic conditions, cultural change will not happen quickly. Thomas Kuhn’s study of scientific revolutions[1] observes that researchers trained in one paradigm rarely abandon their way of thinking in the face of contrary evidence. It is the younger generation who embrace the new paradigm.

The same may be true for risk and compliance in the financial world.  It’s not easy to teach old bankers new tricks. Durable reform of banking culture may need to await the maturation of a younger generation of bankers schooled in different ways of thinking.

Even if efforts at cultural reform are effective and durable, moreover, we should be cautious about the potential downsides.

Bankers should not be clones or puppets. The energy, intelligence and imagination displayed by those who profited from the credit bubble were good attributes, even if they were directed in the wrong way. The instruments these people invented or exploited – credit default swaps, collateralized debt obligations, structured financial transactions, and the like – didn’t cause the crisis and are not intrinsically toxic. They create risk, but if properly controlled they also hold promise to materially enhance consumer welfare.

It’s tempting to yearn for a return to mid-twentieth century finance – a world where banks didn’t fail and market volatility was low. But a consumer of today, if transported to that golden age, would not be very happy with the quality or cost of the financial services she received.

Banking in those days was a government-sponsored and government-enforced cartel in which depository institutions enjoyed local monopolies and access to free money. Bankers wore regimental ties, teed off at three, and prided themselves on never doing anything for the first time. That culture gave value to probity and moderation, but it was not one we should wish to revive.

Banking today faces existential threats on both sides of the balance sheet. Fintech firms and peer-to-peer lenders promise fast, cheap, and nimble financing. Meanwhile, block chain technologies threaten banks’ traditional hegemony in payments services.

Banks must respond effectively to these challenges. Proposed reforms to banking culture would accomplish little if they created dinosaurs that cannot adapt when the next asteroid strikes the financial world.

Thoughtful commentators such as Thomas Baxter of the New York Fed recognize that proposals to improve banking culture are not panaceas.  Baxter and other thought leaders are careful to qualify their support of the cultural approach with recognition of its limitations.

But these grace notes of caution can easily be missed in the drumbeat of enthusiasm for cultural reform.

We should proceed with efforts to improve attitudes and norms in the banking sector. But we should do so with recognition that our ability to change culture is limited, that overconfidence in actions being taken can be as dangerous as failing to act at all, and that no matter how attractive the idea of cultural reform might appear at first, it is likely to disappoint those who seek a universal antidote to problems of risk-taking and misconduct in financial services firms.

[1] Thomas S. Kuhn, The Structure of Scientific Revolutions (50th Anniversary edition 2012).

Geoffrey Parsons Miller is the Stuyvesant Comfort Professor at NYU Law School, co-director of the law school’s Program on Corporate Compliance and Enforcement, and author of “The Law of Governance, Risk Management and Compliance” (Wolters Kluwer 2014).

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