“Enforcing norms of prudence and restraint in a manner that is perceived as fair should be done by a manager – not by a model”
Faced with the limits of the financial reforms introduced since 2010, central bankers and regulators have recently turned to bank culture. This is not entirely unexpected, for reforms such as separating proprietary trading from commercial banking were structural. Durable organisational change requires a cultural approach too.
The problem with the new shift to culture, however, is the practice. Visitors who walked into the lobbies of the large banks over the past decade were often confronted with large signs that announced the espoused values of the bank: ‘honesty’, ‘transparency’, and soon. But in the absence of a more integral reform of the metrics, practices and tools used by the bankers, those words run the risk of sounding hollow.
Going beyond values, however, is not easy, not least because decision-making in finance is highly technical these days. The introduction of economic models such as Black-Scholes and tools such as the Bloomberg Terminal have revolutionised the practice of finance. Some have argued that poorly understood models added to systemic risk in 2008, while others contend that models reduce biases. So how do models and morals come together?
TAKING CONTROL
In my new book, Taking the Floor, I argue that the introduction of models in Wall Street banks threatens to alter the nature of the banks, altering the degree to which ethical norms are enforced, self-enforced and interpreted at various levels. These include corporate strategy, top management discourse, managerial control and customer relations.
Consider, for instance, the problem of control. Models can give rise to perceptions of organisational injustice when they are used for the purpose of risk management. Risk models often flag up a trader’s position as overly risky, forcing the trader to close the position down. But in many cases the red flag is inaccurate and the model leads to the cancellation of a trade that would have gone on to produce high returns. The result is traders that feel unfairly treated, leading to something psychologists call ‘moral disengagement’. This involves the disabling of the mechanisms of selfcondemnation that are typically associated with immoral conduct. This opens the bank to the unrestrained pursuit of self-interest by their traders.
Disengagement can be avoided through organisational strategies and practices. These can take place at multiple levels, but consider the specific case of control. Enforcing norms of prudence and restraint in a manner that is perceived as fair should be done by a manager – not a model. The manager is best prepared to understand the rationale for a trader’s position. They can also explain why it is too risky if it does need to be liquidated. More generally, banks need to understand the power of norms and not just of incentives, that is, the moral dimension of their activity. Bank managers can mobilise and enforce norms in offsite meetings, internal labour markets, or through an organisational layer of middle managers.
ENFORCING NORMS
Nevertheless, the primary enforcement vehicle is one-on-one interactions between employee and line manager. This enforcement of norms requires limiting the use of models for the purpose of control, as models constitute a rival and often incompatible source of authority. I refer to the deployment of organisational measures to prevent model-based moral disengagement as proximate control.
By relying on proximate control, my study suggests that banks can go beyond superficial advertising of the organisation’s values, thereby avoiding the sense that such policy is simply ceremonial. Regulators and central bankers are right to target bank culture in order to complement post-crisis regulations. However, shaping bank culture in modern, quantitative financial markets calls for a sound and detailed understanding of how models and morals come together.