The Business of Banking is the Business of Behaviour
David Grosse
Behavioural Science, Culture and Conduct Consultancy in Financial Services
(Suppositions on the Sounds of Silence, Silvergate, Silicon Valley, Signature, and the Suisse[i])
“Hello darkness, my old friend, I've come to talk with you again
Because a vision softly creeping, Left it’s seeds while I was sleeping
And the vision that was planted in my brain
Stop what you are doing now, turn off Simon & Garfunkel on the radio and listen carefully to the ambient sound. Can you hear it?
Just beyond the sound of silence; a blend of the creaking gate of banking history repeating itself, the hiss and pop of bubbles bursting, the distant rolling thunder of stampeding hooves, mixed with the high pitched whine of people claiming prescience / vindication / ignorance / despair (delete as appropriate).
Can we extract some signals from the noise?
I don’t have sufficient technical knowledge to be able to argue the case on the rights and wrongs of wiping out the value of AT1 bonds versus shares[iv] (or did the CoCo’s pop?), nor whether the central banks were raising interest rates too quickly in tackling inflation.
After all, who within a bank could possibly have known that they needed to manage their interest rate risk? Perhaps they were struggling with the “salience theory of choice under risk” where true probabilities are distorted in favour of what is front-of-mind[v]. The banking equivalent of driving rather than flying to mitigate risk.
Nonetheless, I do have some insights from the current unfolding debacle because (to paraphrase Richard Chataway):
“If you are in the business of banking you are in the business of behaviour”[vi]
If you heard a commotion in the bushes followed by the sight of your kin sprinting across the savannah then you ran first, and rationalized the reasons later. A handy short cut that kept you from the lion’s jaws. The downsides of a regular false alarm (racing heart and shortness of breath) were a price worth paying for the occasions when the threat proved real.
As noted in a recent CNBC article:
“The panic-induced customer withdrawals that imploded Silicon Valley Bank and Signature Bank, and sent shock waves through financial markets and the broader banking system, offer an acute lesson in human psychology”.[vii]
Our brains are hardwired to both run and bank-run, and therefore the fate of some institutions over the coming weeks, months and years will depend on the unpredictable dance of depositor psychology and what makes them take fright.[viii]
So what salient signals will set us all off?
Whereas our fight or flight response could be set off by an unexpected crack of a twig, historically bank runs would be slower to get going, there being few contemporaneous signals, unless you passed a jostling queue of customers outside the front door before opening time.
Even the 2008 GFC took place when the i-phone was only 1 year old and early stage Twitter had 1/400th of it’s current user base.
The ubiquity and speed of information now means the unexpected warning squark of a watchful bird is matched in immediacy by the alarmed tweet of the Twitterati.
There was an evolutionary advantage in being able to quickly detect patterns from limited information, and whilst we may sometimes have mistaken a shaded rock for a face[ix], or a swaying tree for a hunter, on balance these skills were vital, both socially and in detecting predators.
So it is not unusual that we look to quickly decode limited information into what we perceive as a meaningful pattern.
Nor is it surprising that we observe the group norms and follow suit, and that our tribe may have become our social media community, or those who live with us in Palo Alto or Zurich, and that with a few taps and swipes on the screen we have assuaged that surge of fear and moved our money someplace else.
A tweet is not in itself a signal, just the rapid means of conveyance in 280 characters or less. ?
What was in those messages doubtless included important information on financial ratios, liquidity risk and maturity mismatch. However, what they also contained were signals of cultural context that eroded trust, a sentiment that “arrives on foot and leaves on horseback”[x].?
Did Silvergate’s alleged relationship with FTX, delayed reporting to the SEC, and lawsuits (on their ability to detect money laundering) help build or erode confidence?[xi]. How about Signature Bank being accused of overlooking the FTX fraud[xii] ?and the close ties and ill-timed clean opinions from their auditors?[xiii] [xiv] [xv]
Investors are claiming SVB failed to disclose how rising interest rates would undermine it’s business model[xvi], which seems startling as it questions whether management grasped the basics of what being a bank entails. Perhaps the lack of a Chief Risk Officer for 8 months played a role[xvii]. Luckily executives at SVB regained their financial savvy enough to sell shares days before the collapse[xviii]
Before moving onto Credit Suisse, it is worth considering the role of fear and contagion. After the SVB collapse twitchy investors started nervously looking into the shadows for other banks that could be in a similar state.
As an article in the Guardian notes:
“At one level, SVB and Credit Suisse have little in common given the differences in their size, assets, clients and even location. But they share a link in that customers and investors lost confidence in both banks, causing a liquidity problem. “The connecting factor is sentiment,” said professor Paul Kofman, business and economics faculty dean at the University of Melbourne”.[xix]
If one incident can be a misfortune and two a trend, then Credit Suisse was firmly in established pattern making mode. When executives spy on each other[xx] and an institution cannot sense something fishy in Tuna Bonds[xxi] then you have a problem. Group norms are key in shaping behaviour, not just for investors and depositors, but also for managers and staff within a bank.
Rather than repeat the whole sorry tale it is worth considering just one angle.
In 2021 the bank published a report based on the independent external investigation into the Archegos debacle[xxii]. António Horta-Osório, then Chairman, said at the time “we are committed to developing a culture of personal responsibility and accountability”, which was prescient given his resignation six months later following covid breaches and extravagant private jet usage[xxiii]
The report also highlighted significant deficiencies in the bank’s culture, “in which profits were prioritized over sound risk management and respect for controls”. Using publicly available information, subsequent actions can be tracked, including the contents of an investor deep dive in 2022[xxiv].
In the face of repeated issues and an existential crisis it is somewhat startling to see linear and simplistic models on planned improvements to “risk-culture” being explained, with little scientific context nor a deeper understanding of psychological and behavioural drivers, and their impact on decisions and actions.
If banks are not able or willing to embrace more mature methodologies and insights into human behaviour with the very future of their firms at stake, it begs the questions – Will they ever? And if not then why not?
Unfortunately, the approach of many banks to understanding and influencing human behaviour is akin to Frankenstein’s monster, with ill-matching body parts spliced together without recourse to science or reason.
A limb from HR, grafted to one from Risk, stitched together with bits of Compliance, plugged into some Business organs and enveloped in Corporate Communications skin. If there is a brain it is often undersized and not wired in.
Lots of teams (think they) own part of the puzzle, but with little coherence in language, philosophy, insights and approach. Perhaps it is the Not Invented Here Syndrome[xxv] that gets in the way of collective action and novel ideas.
Developing some core strength and behavioural muscle that can leverage all areas of bank would be a start.
If resource is being directed towards understanding customer experience, marketing, clients’ behavioural biases (and perhaps the crowd psychology of depositors and investors) then it is not a leap of logic to infer that another group of humans (management and staff) may also be subject to similar foibles and influences, and be worth studying.
In response to the speed of bank collapse accelerated by social media some have suggested a new category of risk is introduced[xxvi].
Beloved of the hammer departments who only see nails, this will slip seamlessly into taxonomy, framework and the 3 lines of obfuscation. RCSAs will be completed, supporting metrics will be produced and the comforting illusion of control will soon be regained.
The complex system of human behaviour will have once again been shoe-horned into the linear system of process and control, suitably detached from messy reality.
The action bias[xxvii] of firms will ensure new frameworks, values statements, training and communications are in place and boxes will be ticked.
As with the wobbling Millennium Bridge in London, unintentional patterns in crowd dynamics can lead to unexpected outcomes[xxviii]
Much of the risk within the wider financial system does not arise from outside or from an act of God, but is created by people interacting with each other. This has been labelled “endogenous risk”,?where the root cause is the interaction of all the players.[xxix]
Sometimes this can lead to systemic risk, where participants start behaving in a synchronized way, and the suffering of one person triggers behaviour that causes distress in another and the effects are onwards amplified. ?
Systemic risk is therefore behavioural risk writ large.
?·??????What not to do (part 3)
Attempting to distil, codify and control the triggers of behaviour and components of culture into a handy framework, procedure or regulation is therefore a fool’s errand, if not accompanied by an equal understanding of the impact of the wider environment, feedback loops and amplification mechanisms. This is especially true as the interventions themselves influence the wider system, often in perverse and unexpected ways.
This applies at both the bank and industry level.
If risk practices coalesce around standard and partial models this helps ensure that they all have the same weaknesses and blind spots. Rather than mitigating danger they can amplify or mask risk[xxx].
What is true for financial risk practices is even more pronounced as you move through the continuum from non-financial and operational risk, into conduct, culture and behaviour, and where any purported elixirs of “measurement” and “management” should be swallowed with a spoonful of salt.
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Nearly everyone now has 3LOD, NFR frameworks, RCSA, Risk Appetite Statements, KRIs, Purpose & Values, and a smorgasbord of other acronyms, all backed up with suitable communications, training and governance.
There have been ever increasing resources focussed in these areas since the turn of the millennium, with Basel 2, the GFC, and multiple scandals. To which the obvious question is - "how's it been going then?"
Unfortunately these often have limited validity in the real world, and are hampered where adherents are more concerned with the purity of the process than the usefulness of the results.
The same problems exist with regulators, whom are an integral part of the financial system, but whose approaches can get overtaken by procedure, and are then as likely to exacerbate as mitigate behavioural risk. As TIME commented:
“The Fed is a technocratic agency. It takes its mandates of price stability and the guarding the health of the financial system seriously, and it’s mandarins have been utterly crucial in times of crises. But the flip side is a tendency to become detached from the real-world implications of their decisions”[xxxi]
A recent blog from the LSE takes a harsher line, concluding:
“Ultimately, SVB demonstrates the difficulty of ensuring financial stability by controlling risk. The financial authorities can never find all sources of risk, and we just end up with an increasingly costly and uniform banking system, hurting the economy and increasing systemic risk”.[xxxii]
Conclusion
As the alarm goes off and the radio turns itself back on, are we Bill Murray, forever doomed to repeat our own Groundhog Day[xxxiii]?
Once again the current shock shows us that human behaviour and psychology is integral to the business and viability of banks, through the actions of investors, depositors, regulators, management and employees; and from there it feeds inexorably into wider systemic risk.
An article in the FT noted:
“There are many lessons to be drawn from this crisis, but my hope is that ultimately the one that will prevail is this: a bank’s culture is too important to treat it lightly. A bout of market volatility after internal failings or even a banker gone rogue can jeopardise the work of tens of thousands of hard-working people who will feel both betrayed and frowned upon just because they worked in the wrong company. Regulators and investors have done a lot of work on this, but evidently there is still much to do”.[xxxiv]
So will banks and their regulators take heed this time, or
“Will the vision that was planted in our brain
Still remain - within the sound of silence?”
Footnotes & References
[i] Alliteration helps memory recall, so I am planning for this article to garner attention and stick in your brain - Lea, R. B., Rapp, D. N., Elfenbein, A., Mitchel, A. D., & Romine, R. S. (2008). Sweet silent thought: Alliteration and resonance in poetry comprehension.?Psychological science,?19(7), 709-716.
[ii] Simon & Garfunkel – The Sound of Silence - The Sound of Silence - Wikipedia
[iii] I am hoping the use of well-known lyrics may also help to kick off Involuntary Musical Imagery (INMI) or “earworms”. Williamson, V. J., Jilka, S. R., Fry, J., Finkel, S., Müllensiefen, D., & Stewart, L. (2012). How do “earworms” start? Classifying the everyday circumstances of Involuntary Musical Imagery.?Psychology of Music,?40(3), 259-284.
[v] Bordalo, P., Gennaioli, N., & Shleifer, A. (2012). Salience theory of choice under risk.?The Quarterly journal of economics,?127(3), 1243-1285.
[vi] The Behaviour Business. Chataway, R. (2020).?The Behaviour Business: How to apply behavioural science for business success. Harriman House Limited.
[viii] Opinion | From bank runs to a credit crunch, the financial future looks bleak - The Washington Post
[ix] Palmer, C. J., & Clifford, C. W. (2020). Face pareidolia recruits mechanisms for detecting human social attention.?Psychological Science,?31(8), 1001-1012.
[x] From the Dutch Proverb – “Vertrouwen komt te voet en vertrekt te paard”
[xv] Sikka, P. (2009). Financial crisis and the silence of the auditors.?Accounting, organizations and society,?34(6-7), 868-873.
[xvi] Silicon Valley Bank: parent company, CEO and CFO sued amid market turmoil | Silicon Valley Bank | The Guardian
[xxi] Credit Suisse agrees to pay $475 million in fines over the ‘tuna bond’ affair in Mozambique. - The New York Times (nytimes.com)
[xxii] Credit Suisse Group publishes the report of the independent external investigation into Archegos Capital Management (credit-suisse.com)
[xxiii] Empty Private Jet Flights Hastened Credit Suisse Chairman António Horta-Osório’s Downfall - WSJ
[xxv] Antons, D., & Piller, F. T. (2015). Opening the black box of “not invented here”: Attitudes, decision biases, and behavioral consequences.?Academy of Management Perspectives,?29(2), 193-217.
[xxvi] ‘The first Twitter-fuelled bank run’: how social media compounded SVB’s collapse | Silicon Valley Bank | The Guardian
[xxviii] Strogatz, S. H., Abrams, D. M., McRobie, A., Eckhardt, B., & Ott, E. (2005). Crowd synchrony on the Millennium Bridge.?Nature,?438(7064), 43-44.
[xxx] Book launch: The Illusion of Control | Systemic Risk Centre. Danielsson, J. (2022).?The Illusion of Control: Why Financial Crises Happen, and What We Can (and Can’t) Do About It. Yale University Press.
[xxxiii] Groundhog Day (1993) Trailer #1 | Movieclips Classic Trailers - Bing video
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Not sure we need a two volume study, rather a return to the "canons of good lending" summed up in the mnemonic, #CAMPARI, character, ability, means, purpose, amount, repayment and insurance. Couple this to stopping the recycling of bank capital through securitisation and, while things may move more slowly, it is not unfair to expect fewer perturbations and crises. Yet a speech given by #AndrewHaldane of the #BankifEngland (available on its website) in Belfast in 2012 provides a useful history of the choppy seas bankers' inappropriate behaviours have caused. One canon in the 1970s when I started my career concerned leverage. Anything over one was a red flag. Now, it seems, everyone is colour blind and if you aren't hugely leveraged some activist investor will come along and yank hard on the lever. The Quaker principles on which a number of UK banks were found are long gone.
Vice President Credit & Risk - Latin America
1 年As the famous quote says, “Culture eats strategy for breakfast”, but also the 3LoD framework, internal controls, audits, RAS, KPIs, risk committees and the like, in a “all you can eat”buffet. Brilliant text! Thank you.
30 Years Marketing | 25 Years Customer Experience | 20 Years Decisioning | Opinions my own
1 年Cc Graham Hill for later
Director of Retirement Solutions at Pokojninska dru?ba A pension fund & founder of Irrational Retirement Blog
1 年Great article, love all the analogies ??
Author, Consultant, Dr. Business Administration
1 年David Grosse "Systemic risk is therefore behavioural risk writ large." Best definition of systemic risk to date!