Joe: The Central Bank Needs New Laws to Generate Cultural Change

Finance Minister Paschal Donohoe has criticised Irish banks for their disgraceful and scandalous misconduct in the ongoing fallout from the tracker mortgage scam.

Donohoe has ordered the Central Bank to investigate Irish banking culture, and promised that the government will introduce new laws and regulations to curb bad behaviour, enhance accountability, and protect customer interests.

The widespread practice of cheating customers out of their tracker mortgages, much like the widespread practice of corporate irresponsibility leading to the recent financial crisis, suggests that the problem is not confined to a small number of individuals or a single institution. The problem is systemic and persistent; changing culture and banking behaviours is crucial.

The issue that now arises is how best to ensure that banking culture does not give rise to excessive risk-taking, and sharp practices that are so pervasive in the Irish banking sector.

Criminal and civil sanctions can play crucial roles in punishing and deterring wrongdoing, but sometimes they are merely a form of damage limitation after the fact. They certainly do not preclude making preventative strategies a priority, and cultural change a necessity.

So how can the Central Bank promote cultural change to ensure that financial institutions will devote enough time and resources so that ethical behaviour is routinised, expected, and lived? Paradoxically, widespread and systemic change may be achieved by focusing on individual accountability for a small number of senior managers.

At present, the Central Bank has insufficient powers to hold senior bankers individually responsible for turning a blind eye to misconduct of those they manage. Though the Central Bank Reform Act 2010 empowered the head of financial regulation to investigate a person’s fitness and probity to perform particular functions and fulfil certain roles, it is likely that this power will only be useful when dealing with incompetence or active misconduct.

This is because the legislation states that senior managers will generally only be removed where, for example, they lack the necessary experience, qualifications or skills; have participated in serious misconduct, provided false information to the Central Bank; or been convicted of money laundering or terrorist financing or an offence involving fraud, dishonesty or a breach of trust.

While the fitness and probity powers have yet to be fully tested in court, it seems that the Central Bank will have considerable difficulties where senior managers are wilfully blind to misconduct. At present, if they can close their eyes to wrongdoing, claim ignorance or hide behind collective decision-making, it is unlikely they will be held individually responsible.

By contrast, the Senior Managers and Certification Regime (SMCR) in the UK emphasises the importance of individual accountability for senior bankers.

Since 2016, banks in the UK must allocate to its senior managers the business areas for which that designated individual is responsible. The manager must sign a statement recording these responsibilities. The financial institution then maps these responsibilities across the organisation, outlining the various governance arrangements so that reporting lines and structures are clear.

Crucially, these senior managers then have a statutory duty to take all reasonable steps to prevent regulatory breaches in their areas of responsibility. While senior managers may delegate responsibilities, they may not absolve themselves of them; activities must be managed and monitored.

The emphasis on individual accountability is clear. The SMCR makes it easier to identify which senior manager is responsible for failing to address wrongdoing within their area of activity and influence. This forces senior managers to “own” the activities of those it oversees.

If there is information that they could and should know, it is no longer a defence to choose not to know. Low-level wrongdoing, say by bank staff selling mortgages, becomes a specific named director’s personal problem, and that changes the tone at the top, which informs the behaviour at the bottom.

In the UK, senior managers who do not properly discharge their responsibilities can be fined, suspended from their functions, or prohibited from holding a senior management position.

The Irish government must adopt similar systems of individual accountability to drive cultural change so that bankers will treat their customers better, act ethically, and embed good governance in their corporate culture.

The goal must ultimately be to make corporate actors internalise governance norms so that they obey the law because they recognise that it is both the right thing to do and in their interest, though sanctions will always be necessary when they don’t.

[UPDATE: This article was updated on 14 February at 14:09, to correct the year in which changes came in in the UK. Apologies for the editing error.]