St Andrews and Edinburgh uni study finds dangerous links between risk taking, profit and culture in banks

New research carried out by the University of St Andrews and the University of Edinburgh Business School, has found that banks whose corporate culture leans towards aggressive competition are associated with overall riskier lending practices, causing vulnerability to the financial system.

The ground-breaking study, forthcoming in the British Journal of Management, shows that the competitive culture of banks encourages employees to take excessive risks to meet sales targets. The new study is the first to support the theory that corporate culture and risk are directly linked, using empirical data.

The corporate culture within a bank lies at the heart of its associated risk-taking behaviour, as a result this plays a key role in influencing bank profitability, as well as stability of the entire financial sector.

The banking industry is one that incentivises profit over people but the extent of the risk to reach profit is influenced by a bank’s corporate culture.

The researchers used textual analysis on a large sample of bank annual reports to classify banks into having one of the following four corporate cultures: compete, create, control and collaborate.

Banks that frequently mention words such as “aggressive” and “competition” were classified as having a compete-oriented culture. Compete banks embrace risk-taking through aggressive competition and focus on gaining market share. At the other extreme, banks that frequently mention words such as “control”, “risk management”, or “safety” were classified as having a control-oriented culture. Control banks focus on safety and place an emphasis on predictability, conformity, and compliance. Create-oriented banks and collaborate-oriented banks lie somewhere in between, the former focuses on innovation and the latter focus on harmony of people within the organisation.

The study also highlights that, despite technological advances in the banking industry, lending decisions remain inherently subjective. Banks still require credit officers to manually process, collate, and evaluate borrowers’ information. Subjective decision making with regards to lending can therefore be heavily influenced by corporate culture, encompassing the norms and practices around how lending decisions are made within the bank.

Dr Louis Nguyen, lecturer from the School of Management at the University of St Andrews, said: “The issue of corporate culture in banks has attracted a lot of attention from financial regulators, politicians and the media since the 2008 financial crisis. Recent scandals, such as one from Wells Fargo, shed further light on the “throat-cutting” competition-oriented culture in the banking sector. Financial regulators around the world, such as the Federal Reserve Bank of New York, the Financial Conduct Authority and the Dutch Central Bank, emphasised the importance of improving bank culture to foster stability and global trust in the banking sector. Our findings therefore echoed this view of regulators on the role of corporate culture on bank risk-taking and bank conduct.”

The findings reported in the paper are consistent with these concerns and suggest that banks with a risky culture are likely to bear adverse long-term consequences, despite the immediate growth and revenue.

Dr Linh Nguyen, also a Lecturer from the School of Management at the University of St Andrews, commented: “Apart from showing the big picture that bank culture has a serious implication for the public welfare, we suggest that it is better to be slow and safe than fast and furious. We find that banks with risky culture enjoy aggressive lending growth during good times and have to pay a price when the economy becomes distressed. On the other hand, banks with a safety culture experience conservative growth but are healthy when facing a difficult period.”

Furthermore, the findings also imply that the piecemeal regulator responses around governance and executive compensation structure may not be sufficient in curbing a bank’s excessive risk-taking.

Dr Vathunyoo Sila, lecturer from the University of Edinburgh Business School, added: “Even when we take into account many factors that have long dominated policy discussions such as executive pay, corporate governance, and bank business models, corporate culture of banks remains a very significant determinant of their risk behaviour and ultimately the overall stability of the financial system. Given the current debate on bank culture, our findings resonate the view of many regulators that understanding the culture of banks should indeed be their utmost priorities.”