In our recent paper on Culture in Financial Services, we highlighted that one of the key questions supervisors consider when assessing a firm’s culture is whether it promotes constructive challenge at all levels in the organisation. The underlying supervisory concern is whether there is any tendency towards “group-think”, especially at board level.
In this crucial regard, supervisors are highlighting, with increasing frequency, the role that diversity and inclusion play in improving culture within firms. In Ireland, the Central Bank (CBI) recently conducted diversity and inclusion assessments in Irish retail banks in parallel with its review of Behaviour and Culture1 . These found that the banks “have much more work to do in terms of ensuring their organisations are sufficiently diverse and inclusive, particularly at the senior levels, to prevent groupthink, guard against over-confidence and promote internal challenge”.
The CBI’s report echoes a consistent message over the past 12 months from top officials at the UK’s FCA (Andrew Bailey, Megan Butler and Christopher Woolard), each of whom has spoken2 on the importance of diversity and inclusion to fostering better culture in FS firms.
The message, in short, is that supervisors in these jurisdictions are increasingly inclined to see a homogenous or “non-diverse” board and senior management as creating a heightened risk of group-think which may well percolate throughout the organisation. Accordingly, as part of their continued focus on firms’ governance and culture, they intend to step up their scrutiny of how firms are approaching diversity and inclusion.
Similar notes are being struck at cross-jurisdictional and global levels. At the European level new board suitability guidelines from the EBA and ESMA came into force in June. These guidelines, which have been incorporated into the ECB’s fit and proper assessments, seek to strengthen corporate governance, inter alia, by setting out how different aspects of diversity should be taken into account in the recruitment process for members of the Board. And from a global macroeconomic and systemic perspective, Christine Lagarde, reflecting3 on the financial crisis ten years on, has highlighted the IMF research finding that a higher proportion of women on the boards of banks and supervisory authorities is associated with greater financial stability.
Diversity as a supervisory tool to improve firms’ culture
The CBI’s report cites a range of evidence4 to support its view that diversity and inclusion, in all their forms, are important “to well-managed, financially resilient, strategically minded firms”. The CBI observes that, in its experience, a lack of diversity at senior levels is a leading indicator of “elevated” behavioural and cultural risks. The CBI is therefore expecting all banks to take meaningful action to address the lack of diversity and inclusion at senior levels in order to improve cultures. If, in its view, improvements do not materialise, it will “consider whether it is necessary to put further specific requirements in place”.
For its part, the FCA has identified a clear link between diversity and improved culture and decision-taking. According to Megan Butler, “firms that promote gender diversity … significantly lower their conduct risk. And this is where the FCA’s interest comes in. Firms with monocultures suffer 24% more governance-related issues than their peers”. Consequently, the FCA is looking for sustained board and senior management commitment to delivering meaningful diversity:
“The industry should be clear that the current pace of change on gender diversity must not just be a flash in the pan, but must be maintained”5
To address the risk of group think and promote independence of thought, the FCA is clear that firms’ approach to diversity and inclusion must be about encouraging a broad group of people, with different experiences, to consider and challenges issues from different angles. It has signalled that it will be alert to “tokenism”; that is, appointing individuals who are seemingly diverse but who fundamentally share the same background, perspectives and outlook as existing staff. In this regard, Christopher Woolard has commented that genuine diversity and inclusion will not be achieved “by employing the sisters of your existing board members”. In a similar vein, the ECB has highlighted the need for banks to ensure that all board members are “independent thinkers”6 .
How can firms respond?
Regulators recognise that changing cultures, including by improving diversity, cannot be achieved overnight. Nevertheless, the FCA and CBI have clearly signalled a more intrusive supervisory approach to diversity issues, as part of the wider and growing supervisory focus on culture, and it is possible that other regulatory authorities will adopt a similar approach. This focus is likely to include scrutiny of key statistics and indicators and how diversity issues are captured within firms’ MI.
In particular, we expect that supervisors will probe:
The tone from the top - Regulators have repeatedly stressed the importance of the tone from the top in establishing the right values, attitudes and culture throughout a firm. The FCA has emphasised that its supervisors will “impress upon senior managers the importance of diversity within their teams”7. We expect that, in parallel, they will scrutinise Senior Managers’ attitudes and practical approaches towards diversity.
Diversity policies - Supervisors will increasingly expect all firms (not just those subject to the EBA/ESMA guidelines) to have in place specific policies promoting diversity amongst their board and senior managers. They will expect these policies to cover diversity in its widest sense, including educational and professional background, gender and age.
Diversity across all employees – the FCA speeches suggest that their supervisors will be looking for evidence that a firm has a long term strategy to deliver enduring diversity at all levels of the organisation. In this regard Megan Butler observes that “you cannot solve this problem by parachuting in a handful of senior women”. In sum, we expect supervisors to focus increasingly on how firms are building a diverse long term pool of candidates for future senior positions.
Diversity ambition - The CBI’s review of culture in banks expressed the concern that most targets for diversity at board level were “one dimensional” and “limited in terms of ambition”. Their expectation is that firms will set ambitious targets and practical steps and measure their progress against them regularly and, most importantly, in terms of outcomes.
A broad definition of “diversity” - Whilst gender diversity continues to attract significant attention, (the European Parliament, for example, recently proposed amendments to CRD IV to require remuneration policies to be gender neutral), we expect supervisors to focus increasingly on diversity in its widest sense and how this contributes to what Chris Woolard characterises as greater “diversity of thought”. In Ireland, the Central Bank has noted that, while still focused on gender diversity, the banks it considers most “advanced” on diversity matters had expanded their approaches to consider different aspects of diversity.
1Central Bank of Ireland, Behaviour and Culture of Irish Retail Banks
2Andrew Bailey, Transforming culture in financial services; Megan Butler, Women in finance: keeping up the pressure for progress; Christopher Woolard, The art of thinking independently together – why the regulator cares about diversity.
3Christine Largarde, Ten Years After Lehman—Lessons Learned and Challenges Ahead
4The CBI report states that “research suggests that diversity at senior levels can help to reduce the likelihood of group-think, improve decision-making, increase the level of challenge and improve risk management”. A selection of the references cited by the report are listed below:
- Daily, C.M., Dalton, D.R. and Cannella, A.A. (2003) ‘Corporate governance: Decades of dialogue and data’ Academy of management review
- Hoogendoorn, S., Oosterbeek, H. and van Praag, M. (2013). ‘The impact of gender diversity on the performance of business teams: evidence from a field experiment’. Management Science
- Terjesen, S., Sealy, R. and Singh, V. (2009). ‘Women directors on corporate boards: A review and research agenda’. Corporate Governance: An International Review
- Adams, R.B. and Ragunathan, V. (2015) Lehman sisters. FIRN Research Paper
5Megan Butler, Women in finance: keeping up the pressure for progress, 2018
6EB, Good governance in a changing environment, 2018
7Megan Butler, Women in finance: keeping up the pressure for progress, 2018