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The 2007-09 financial crisis exposed numerous vulnerabilities of the financial system that arise from failures within individual financial institutions and lead to heightened systemic risk. Many have argued that these failures can be traced back to corporate governance weaknesses in banking. Regulators in the U.S. and Europe have shown increasing interest in examining the extent to which these corporate governance weaknesses are linked to the “softer” aspects of governance in banking like corporate culture, in addition to the more familiar aspects of corporate governance like executive compensation, board independence and so on. This has led to an emerging discussion on how to define bank culture, how to measure it and how to change it, as well as the impact it has on the bank’s measurable economic outcomes. These are all new issues in research as well evolving regulatory policy, so it is worth reflecting on their relationships and potential for shaping banking in the years to come.

This paper examines the roles of ethics, culture, and organizational higher purpose in the conduct of corporate governance in banking.  Developments in these related but distinct areas since the financial crisis are discussed. A framework for gaining a tangible view of bank culture and measuring culture is discussed.  The roles of executive compensation and better market discipline from bank equity are examined in the context of bank corporate governance.  The main conclusion of the paper is that we need to strengthen capital ratios and equity governance in banking to improve ethics and culture, and de-emphasize liquidity regulation.  Another conclusion is that the embrace of authentic organizational higher purpose in banking—through dialog between regulators and banks rather than regulation—should enhance the effectiveness of corporate governance in banks, increasing employee commitment and burnishing the reputations of banks. Further, it will work in concert with prudential regulation to achieve greater financial stability and economic growth in banking. In other words, authentic higher purpose can elevate the effectiveness of other aspects of corporate governance in banking.

This paper has important implications for both the management of banks as well as the regulation of banks. Bank managers need to focus compensation to de-emphasize dependence on Return on Equity (ROE), strengthen their culture through a rigorous diagnostic and change process (the paper discusses a tool to do this), and embrace an authentic higher purpose that drives culture and employee behavior that reflects a deeper commitment to the organization and a higher level of engagement. Regulators can focus their attention on strengthened capital regulation and de-emphasize liquidity requirements.

 

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