2008 – The scale of the financial crisis showed us that supervision on figures and facts no longer sufficed. More than ever, we realised that our supervisory scope should be extended to include the people who pull the strings. Acting on this lesson, DNB launched a new kind of supervision in 2010; supervision of behaviour and culture. This book addresses questions such as How should we start this type of supervision? What tools and theoretical background should we apply? What kind Supervision of Behaviour and Culture of expertise is needed? Its foundation Foundations, practice & future developments & future Foundations, practice lies in a systematic approach based on field experience and substantive scientific research. Plus a deep-rooted conviction that this kind of supervision is a much-needed additional tool to further strengthen supervision. Supervision of Behaviour and Culture Foundations, practice & future developments De Nederlandsche Bank N.V. Postbus 98, 1000 AB Amsterdam 020 524 91 11 dnb.nl Supervision of Behaviour and Culture Foundations, practice & future developments 2 Supervision of Behaviour & Culture 3 Content Overview Foreword 9 Frank Elderson 1 Why this book? 13 Mirea Raaijmakers 1.1 A book for our collegues 13 1.2 The case for supervision of behaviour and culture 14 1.3 Five years of expierence have had positive effects 16 1.4 More than 50 assessments conducted since 2010 16 1.5 Results of management assessment 19 1.6 Results of change capacity review 20 1.7 The three parts of this book 21 Part I - Foundations 2 The Rationale for Supervision 26 of Behaviour and Culture Wieke Scholten and Mirea Raaijmakers 2.1 Introduction 27 2.2 The importance of supervising behaviour and culture within financial institutions 28 2.3 The legal framework for banks under Dutch law 31 2.4 DNB’s supervision of behaviour and culture 34 2.5 The psychological paradigm 35 4 3 Model and Basic Assumptions 42 Mirea Raaijmakers 3.1 Introduction 43 3.2 Definition of culture 45 3.3 DNB’s model on behaviour abd culture: the iceberg 47 3.4 Risk focus based on the iceberg 52 3.5 Basic assumptions of supervision of behaviour and culture 53 4 Supervisory Approach and Methodology 64 Mirea Raaijmakers 4.1 Introduction 65 4.2 DNB’s risk-based supervisory cycle 66 4.3 Core elements of supervision of behaviour and culture 69 4.4 The Supervision cycle for behaviour and culture 73 4.5 Context analysis 74 4.6 Behaviour and culture risk identification – what are our points of interest? 77 4.7 Behaviour and culture risk assessment – what do we see? 84 4.8 Behaviour and culture risk mitigation – what do we expect? 88 Part II - Practice Focus on Group Effectiveness 5 Decision Making 102 Wijnand Nuijts 5.1 Introduction 103 5.2 Assumptions 104 5.3 Risk identification – what are our points of interest? 115 5.4 Risk assessment – what do we see? 123 5.5 Risk mitigation – what do we expect? 125 5.6 Conclusion 132 Supervision of Behaviour & Culture 5 6 Leadership 138 Moritz Römer 6.1 Introduction 139 6.2 Why leadership is relevant for supervision 140 6.3 Assumptions 141 6.4 Risk identification – what do we look at? 144 6.5 Risk assessment – what do we see? 157 6.6 Risk mitigation – what do we expect? 161 6.7 Conclusion 165 7 Communication 170 Mélanie Rouppe van der Voort 7.1 Introduction 171 7.2 Communication 173 7.3 Risk identification – what are our points of interest? 175 7.4 Risk assessment – what do we see? 182 7.5 Risk mitigation – what do we expect? 188 7.6 Conclusion 194 8 Group Dynamics 198 Anoushka Wajer and Wieke Scholten 8.1 Introduction 199 8.2 Assumptions 201 8.3 Risk identification – what are our points of interest? 209 8.4 Risk assessment – what do we see? 216 8.5 Risk mitigation – what do we expect? 219 8.6 Conclusion 223 6 Part II - Practice Focus on Change 9 Capacity for Change 226 Jildau Piena 9.1 Introduction 227 9.2 Assumptions 228 9.3 Supervision model on capacity for change 231 9.4 Practical application: two years of research into capacity for change 233 9.5 Risk identification – What are points of interest? 234 9.6 Risk assessment – what do we see? 238 9.7 Risk mitigation – what do we expect? 244 10 Culture Change 250 Mirea Raaijmakers and Wieke Scholten 10.1 Introduction 251 10.2 Supervision model on culture change 251 10.3 Key criteria 255 10.4 Risk identification – What are our points of interest? 258 10.5 Risk assessment – What do we see? 266 10.6 Risk mitigation – What do we expect? 271 Part III - Future Developments 11 Error Management in Financial Institutions 280 Wieke Scholten 11.1 Introduction 281 11.2 Responding to errors 282 11.3 Error management culture: an organisational approach to errors 285 11.4 Error management culture improves organisational performance 289 Supervision of Behaviour & Culture 7 11.5 Improved organisational performance explained: underlying mechanism 291 11.6 Supervisors can ask financial institutions to improve their error management culture 294 11.7 Taking an organisational level perspective 296 11.8 Putting leadership to work 298 11.9 Conclusion 300 12 The way forward for effective external supervision is to influence internal supervision 304 Melanie de Waal 12.1 Introduction 305 12.2 The influence of internal and external supervision on individuals’ decisions 308 12.3 How does supervision influence people in their decision-making? 309 12.4 Why does internal supervision have such a big influence on decision-making? 311 12.5 How does the combination of internal and external supervision influence decision-making 312 12.6 Additional research into the effect of different types of internal and external supervision 313 12.7 Practical implications for external supervision 316 12.8 Conclusion 319 Annex 322 Introducing the team of supervision of behaviour and culture and the authors 8 Supervision of Behaviour & Culture 9 Foreword Dear colleague supervisor, Thank you for taking an interest in this book. The result of thorough research driven by conviction, it captures the views and experiences of many men and women who believe it is time to considerably broaden our take on the financial world. The scale of the financial crisis erupting in 2008 brought home to us that, in assessing a financial enterprise’s health, it no longer sufficed to look just at facts and figures. More than ever were we aware that our supervisory scope should be extended to include the people behind these figures and facts, those that pull the strings. After all: if the ripples created by a pebble thrown into water have a distorting effect, it is not the pebble that should be held accountable, but the hand that threw it. Acting on the lessons thus learnt, in a few years’ time, De Nederlandsche Bank increased its supervisory staff with colleagues specialised in assessing behaviour and culture. Initially, this new strategy met with scepticism, not just outside our organization, but also internally. Were we not acting beyond our remit and treading on the territory of consultants? And was this not a far cry from facts and figures, which are so blissfully concrete? We responded by pointing out our mission statement, which reads that De Nederlandsche Bank “seeks to safeguard financial stability…”, and that in light of that mandate we must keep a close eye on anything that may put this financial 10 stability in jeopardy. Naturally, this includes a financial institution’s behaviour and culture. Five years on now, we are happy to report that our endeavours have been increasingly rewarding and that some countries are following suit. The initial scepticism has gradually made way for genuine appreciation, both from institutions whose behaviour and culture we examine and from our supervisory colleagues at home and further afield. In short, there is every reason for us to continue on this path and for supervision on behaviour and culture to be further explored. The latter preferably not just by us, your colleagues at De Nederlandsche Bank, but together with you. We therefore invite you to participate in this exploration, by sending in your comments on this book, and by sharing your experiences and thoughts. In other words: may the ripples created by the pebble we have thrown, reach you! Yours sincerely, Frank Elderson Executive director Supervision of Behaviour & Culture 11 su -crisis perv st isio Po n Fit & proper testing Bench Stress marking testing Macro prudential analysis Risk management a l Business Financial d a models reports d n i o t i i t o i Sound Behaviour n d operations & culture a a policy r Board l t eectiveness AML/CFT Compliance Thematic Operational investications risk management 12 Rationale for supervision on behaviour & culture Model & Basic Focus on Group Assumptions E ectiveness Supervisory Focus Approach & on Change Methodology Part I The Foundations - Chapters 2-4 Part II Future Our Practice Developments - Chapters 5-10 Part III Future Developments - Chapters 11-12 Supervision of Behaviour & Culture 13 Why this book? 1.1 A book for our colleagues Since the financial crisis, behaviour and culture have been important issues for financial institutions and their internal and external supervisors. In 20101, DNB initiated, developed and implemented a new supervisory approach that focuses explicitly on behaviour and culture risks. Now, in 2015, we celebrate the fifth anniversary of our supervision of behaviour and culture. Internationally, there is considerable interest in our behaviour and culture supervision, both from the financial sector and its supervisors in other countries and from other sectors.