Culture matters - The ECBs approach to assessing banks' culture and risk behaviour

Published Date
Sep 26, 2023
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A recent speech by Frank Elderson, Vice-Chair of the ECB Supervisory Board, places culture firmly on the supervisory agenda. Mr Elderson considers how culture can drive risk behaviour in banks how the ECB goes about assessing banks’ culture. Foreshadowing an even greater supervisory scrutiny on the issue, he announced detailed supervisory guidance on risk culture for 2024.    

How culture can lead to financial scandals? 

Mr Elderson linked culture to the major financial scandals of the last two decades, such as the Lehman Brothers and SVB failures. He argued that the culture of these banks enabled risky behaviour that eventually caused their collapse. Culture is a vital factor for banks’ performance.

What is culture and why does it matter? 

Mr Elderson defined culture as the “collective mindset and shared sets of values” that like an “invisible hand” shapes the “everyday behaviour” of banks’ employees. That behaviour is an observable manifestation of the bank’s “collective ethos”. In essence, a bank’s culture shapes behaviour and can result in prudence or recklessness.

Culture as part of internal governance supervision 

If the “wrong” culture can drive excessive risk-taking and lack of compliance with supervisory standards, it becomes a prudential concern. While it is for banks themselves to define their culture and values, it is the role of the supervisor to assess whether the culture they define is aligned with prudent risk-taking. 

The ECB views culture to be part of internal governance supervision. This entails specific qualitative requirements that banks must meet. The ECB considers culture supervision as essential to see the whole picture and go beyond formal rules and procedures to how they are actually applied across the organisation on an everyday basis.

When supervising behaviour and culture, the ECB looks at both the "hardware" of banks' governance (their policies, management body set-up and composition) as well as the "software" (how people behave within the governance structures). 

One crucial element the ECB is looking for in an organisation’s culture is the quality of debate in the management body and whether critical discussions are taking place. As part of a recent review of management body effectiveness, the ECB found that such a “culture of constructive challenge” was often lacking. 

Supervisory tools for assessing culture and behaviour  

Attending board meetings

To evaluate the culture of constructive challenge in practice,  the ECB occasionally observes board and committee meetings at supervised banks. This allows it to see if the CEO or Chair exercises a dominant role and which topics are in focus and which neglected. Mr Elderson however stresses that the ECB is not looking for regular participation or to take the steering wheel out of the hands of management.

Risk culture assessment

In assessing an institution’s risk culture, the ECB focuses on the “tone from the top”, which is crucial for the question of (prudent) risk-taking within the bank The ECB checks whether board members incorporate the bank’s stated values and norms in their decisions.

The ECB also interviews board members and staff to assess risk behaviour and find out how seriously compliance is taken on a daily basis.

For a small group of banks, the ECB has recently piloted risk culture deep dives and it remains to be seen if these will be rolled out.

On what basis does the ECB act?

Addressing a common criticism that the ECB is overstepping its mandate by supervising culture and attending board meetings, Mr Elderson cites several legal sources including Article 98(7) CRD and EBA Guidelines on internal governance.

What to expect  in 2024 and beyond?

Mr Elderson announced that the ECB is working on a supervisory guidance on risk culture, which will be published in the final quarter of 2024. This guidance will set out the ECB’s supervisory expectations on governance, risk management and risk culture in detail. The guide will also include a set of good practices as has been seen in other recent ECB guides eg the 2022 Good practices for climate-related and environmental risk management.

Mr Elderson’s speech signals that culture is back on the ECB’s supervisory agenda and that banks should expect more scrutiny on this topic in the coming years. It would be no surprise to see it mentioned explicitly in the next update to the supervisor’s medium-term priorities to be published towards the end of 2023.

Further reading

Read the full speech here. 

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This content was originally published by Allen & Overy before the A&O Shearman merger