Risk Culture in Banking

Studies on corporate culture have been carried out for a long time. Corporate culture has been a popular management tool since the early 1980s and, more recently, an intense activity of research on this subject (arisen from the failure of traditional cultural models) turned cultural explanations into a more valuable asset than a simple matter of “claiming the residuals” (Zingales 2015).

This chapter is about the relationship between business and risk culture in financial institutions. A conceptual model is elaborated, which links the main lines of research and the relevant variables. There are three categories of business-related determinants of risk culture: structural, contingent and evolutionary factors. The structural variables are embedded in the nature of the business: the activities performed and their embedded risks, the nature and role of customers, the economics of business. The contingent variables are external; they affect different businesses in a different way (e.g. market competitiveness, regulation, organisational systems).The evolutionary variables have contributed to the weakening of the risk culture in all businesses. As an example, the case of “the rise and fall of risk culture in investment banking” is analysed.

Risk culture deserved increasing attention by regulators and supervisors in recent times, along with the awareness that weaknesses in risk culture were at the base of the global financial crisis and misconduct of many financial institutions. This Chapter focuses on how regulation affects bank risk culture and risk-taking behaviors and how this has an influence on supervisory styles.

This chapter aims to give an overview on the evolution of banking culture, from the culture of control, to the culture of compliance, up to the culture of risk. During the financial crisis, the culture of risk becomes very important, this due to the crucial role that the risk has in the banking business. Risk culture and risk management are close related and in particular, risk culture is a key component of the risk management efforts. Finally, the chapter describes the relationships between the three “lines of defence” and the role of the Board of Directors and top management in the spreading of risk culture among all levels of bank’s organization.

Economists and management researchers often take a reductionist view of risk and culture, and consequently of risk culture. The best contributions on risk culture in financial institutions approach this topic by including many perspectives: in this chapter the core objective is to discuss the main theoretical and empirical findings of different streams of knowledge that are directly or indirectly linked to the role of people in establishing and changing risk culture in financial institutions. Attention is particularly paid to the so called “soft tools” for managing risk culture, within a broader view of organization design, focused on influencing people’s attitudes and behaviour towards risks. Conclusions are devoted to the identification of selected actual and future issues in managing people and risk culture, and of future research streams concerning these issues.

Weak Risk Culture was a driver of banks’ failures after the financial crisis of 2008 (PCBS, 2013). Regulators (FSB, 2014) and practitioners (Deloitte Australia, 2012) developed frameworks to analyse and enforce RC in financial institutions; new pillar III discipline is pushing banks to develop a strong RC (BCBS, 2015). No empirical evidence exists in literature that link RC and banks’ stability. The following chapter tries to fill this gap, it uses Financial Stability Board’s framework (Financial Stability Board, 2014) of Sound Risk Culture (SRC) and extracts the vocabulary associated with a strong RC. Then, it applies quantitative text analysis (QTA) on banks’ disclosure to build a SRC Index. Finally, it analyses the correlation between the index and the Z-score of the banks.

Could risk culture affect financial institutions’ reputation? The chapter aims to answer this question by applying an event study approach to a couple of Italian banks sanctioned for their distorted behaviour. We used these sanctions as a proxy of a poor risk culture within the organization and the decision making process. Abnormal returns we observe in two different time intervals exceed the value of the supervisory sanctions. The exceeding capitalization loss can be considered as a proxy of reputational loss due to lack of risk culture. Our evidence suggests that behaviour could have been better controlled and re-addressed within an environment characterized by a higher risk culture intensity.

This chapter aims to show the mass media role in controlling banks’ risk taking behaviour and in shaping their risk culture. Therefore, we first construct a media attention index based on news coverage from 1998 to 2015 about banking risk issues in EU-15 countries, named Banking Risk Coverage (BRC). Second, we study in the relationship between the BRC index and the asset quality of banks in each country. Our analysis suggests that the BRC index is in many cases positively correlated with the NPL of banks.

This chapter focuses on the relevance of national culture in bank risk-taking decisions. The analysis considers the European banking system and aims to study how different cultural values across countries may affect bank risk-taking. Using firm-level data from 28 EU countries and employing an OLS analysis, we show that individualism has a positive association with bank risk-taking and uncertainty avoidance has a negative association with bank risk-taking. We also find that the large dimension of banks weakens the association of culture with bank risk-taking. The empirical evidence reveals that even in the highly globalized European financial system, with uniform rules of supervision and risk management across countries and in crises times, culture matters.

The European bank system needs to consider the openness of markets of Central and Eastern European countries (CEECs) above other forces among which competition, crises and regulation. This chapter has the aims to understand the impact of national culture on risk-taking by European banks with branches and subsidiaries in CEECs as well as the ownership effects (shareholders, stakeholders). The sample is composed of 328 Eastern European banks in 13 countries and data are from Bankscope. The two measures of culture individualism and power distance affect significantly the risk-taking measured by z-score, while EBRD index records a positive relation. The results on SHV and STV suggest that banks with cooperative BHCs in CEECs have the same behaviour as commercial banks in facing cultural characteristics of a host country.

Each customer is unique. Starting from this perspective, the most recurring promise of the private banking/wealth management players becomes: “Each of our solutions is unique”. As argued in this chapter, the ‘Know your client’ principle and the standard requirements requested by the MiFID framework are not conflicting, but complementary and the second ones are a guarantee from the client point of view. While much less exciting, the most serious promise to the client should be: ‘We are able to keep your risks under control’, and this promise becomes reliable, if the private bank/wealth management unit’s risks are also under control. The private banking/wealth management business models sustainability highly depends on it.

The recent financial turbulence and the increase of the non-performing loans in banks’ credit portfolio highlighted the importance of the banks’ credit risk management and the need to spread the risk culture across the bank organization. This chapter provides an overview of the state-of-art of the credit risk management of a sample of Italian banks. The methodology uses a survey investigating the credit risk management framework of a sample of 27 institutions. Tha dataset has been obtained through a questionnaire sent in the first half of 2016. The results indicate that the banks surveyed have established an adequate organizational design for their credit risk management. The banks have implemented a proper communication system, disseminating the risk culture across the entire organization. However, smaller banks still maintain a more simplified risk management system and, consequently, a smaller team dedicated to credit risk management.

Credit ratings are part of mass media communications and an increasingly important issue in bank-customer relations. We present an inquiry on rating culture involving branch officers, professionals and managers of a sample of banks. It confirms that the misleading messages of mass media are prevailing even among financial industry operators. To clarify the key concepts of credit ratings that should be part of a shared culture, we focus on the borrower/issuer credit ratings and we explain why is normal to have non-aligned ratings issued by different ratings agencies, why these ratings may differ from “implied ratings” (those derived from bond, equity and credit derivatives markets) and from “internal ratings” (those assigned by individual banks, using proprietary data, models and processes).

This chapter studies the relationships between accounting conservatism and bank solidity, both of which have a close relation with risk culture. Analysing a sample of 100 European listed entities that belong to the financial sector observed over the period of 2014–2015 (e.g., 200 firm-year observations), this research tests the hypothesis that a negative relationship exists between accounting conservatism and bank solidity. Results validate this hypothesis, confirming that there is a lower demand for accounting conservatism in the most solid entities. These results validate findings in the accounting literature that accounting conservatism mitigates bankruptcy risk (Biddle et al. in Accounting conservatism and bankruptcy risk, 2016) and thus tend to decrease in the most solid entities.

Typical risks of poor culture reflect in business strategies far from firm values and sound conduct, remuneration criteria facilitating business short-term objectives and failures in accountability. The internal audit function can play a fundamental role in providing either assurance or consulting on risk culture to a company governing bodies. This chapter analyzes the role of Internal Audit on such matter and examines how the audit approach evolves together with the level of pervasiveness of risk culture within the company. In our view, the audit assurance on risk culture shall leverage on an assessment of the comprehensive risk culture framework extended to the entire perimeter of functions of a company (e.g. risk management; compliance; HR; business). Such assessment shall be usefully underpinned by the evaluation of risk culture control objectives and risk culture indicators, aimed to evaluate respectively qualitative and quantitative indicators of risk culture (reported in extent in the appendix). To this end the audit reporting evolves as well, to broaden its perimeter from traditional assurance on the control environment to an assurance on risk culture awareness and management.