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The wrong answer

20 April 2015

The wrong answer - read more

Regulation seems to have achieved little, says Peter Montagnon

The financial crisis unleashed a blitz of regulation on the banking and financial sector, but this seems to have achieved little. Speaking at an investor conference in Madrid last month, David Wright, a senior securities regulator and the architect of the EU’s response to the banks, complained that the sector had not learned anything. It continued, he said, to behave disgracefully and should therefore expect even more severe regulation.

Although his frustration is understandable – banks have been very reluctant to admit to much wrongdoing – it is also possible that regulation has not solved the problem because it was the wrong answer in the first place. Regulation will not solve an issue that is really one about culture and trust, because the very need to regulate implies a lack of trust that cannot be repaired. What we need to do is find a way of transforming the culture in banks – and the corporate sector more generally – so that they actually need less rather than more regulation.

Public trust in business is at a low as a result of scandals reaching far beyond the banking sector: misreporting of financial figures at Tesco, bribery and flawed marketing practices at GlaxoSmithKline, bribery at Rolls Royce, the Macondo disaster at BP and aggressive tax avoidance measures at companies like Starbucks. These all add up to give an impression of a business world which is out of touch with the expectations of ordinary people.

We cannot deal with this by clamping down on business to make it less entrepreneurial and therefore less able to provide the growth and investment needed to rebuild our economy. We must find a way to persuade companies to build a culture that makes them trustworthy again. That will not happen by hitting them with ever increasing amounts of regulation.

Regulators and policy makers find this truth hard to deal with because it suggests that there is not much they can do, and the public are looking to them for a quick fix. Yet the risks that arise from a flawed culture are palpable. There is a cultural aspect to all the problems mentioned above.

Boards and senior management need to take steps to embed a culture that will make their company trustworthy. The initiative has to come from within, but regulators can help by encouraging companies to be more transparent about indicators that are relevant to culture. As compensation, they could perhaps ease the disclosure burden elsewhere. There is almost certainly now too much technical disclosure around remuneration, for example. There should also be a greater emphasis on materiality around the application of financial reporting standards.

Regulators should be more single-minded in pursuing and prosecuting individuals who are guilty of obvious offences. Their track record since the crisis has been poor. It is no compensation to point to increasing fines at corporate level and the invention of new and worrying offences such as reckless decision making. The risk of being prosecuted for obvious misdemeanours should be a real deterrent.

Finally they should look to adjust the mix. We do need regulation, yes, and we also need good governance, though not of the increasingly process-driven kind. We do however need to look more carefully at the impact of competition. One of the problems facing the banking sector was that competition did not work properly, allowing firms to treat their customers with contempt. Weak competition, along with obscure product pricing, exists in other sectors too.

With less emphasis on regulation, and more on culture and competition, we could get to the point where companies are actually competing with each other to offer a good service to their customers. It sounds like a pipe dream, but most people would assume this is what they are supposed to do anyway.  

Peter Montagnon is a keynote speaker on ethics in governance at the ICSA Guernsey Conferece 2015 on 29 April. For more information and to book your place, visit www.icsa.org.uk/events.

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