Is the corporate culture of banks important? A lot of people think so. Several commentators attribute the recent scandal To “toxic” culture. Various regulators, including the United Kingdom Financial conduct authority, From the Nederlandsche Bank, and the Federal Reserve Bank of New York have increasingly emphasized that improving the culture of banks is the key to regaining public trust in the financial sector. Therefore, understanding how banking culture affects financial stability is a big question.
In our recent paper, we examine if and how the corporate culture of banks affects their risk-taking behavior. We focus on bank lending, as a specific channel through which culture can influence risk-taking decisions. Despite technological advances that allow banks to automate lending processes through credit scoring, loan officers remain heavily involved in assessment “sweet information”Such as management talent in business loans, or the borrower’s personal situation in mortgages. In these cases, lending decisions remain subjective and can be strongly influenced by ‘standards” the way loan applications are decided. Additionally and perhaps more importantly, lending is a very fundamental activity of banks and the way lending decisions are made is likely to have a big impact on the economy at large.
We are using Natural language processing on a large sample of annual bank reports to classify them into different cultural categories according to the Competing values framework (CVF), a framework widely used by practitioners to analyze and understand corporate culture. Banks that frequently mention words such as “aggressive” and “competition” were classified as having a culture of competition. Competitive banks embrace risk-taking through aggressive competition and focus on winning market share. At the other extreme, banks which frequently mentioned words such as “control”, “risk management” or “security” were classified as having a culture of control. Control-driven banks focus on security with an emphasis on predictability, compliance and compliance. Creation-oriented banks and collaborative banks fall somewhere in between, with the former focusing on innovation and the latter on the harmony of people within the organization.
Our results echo the point of view of regulators. We find that banks with a growth-oriented culture are more likely to have borrowers with lower credit ratings, while those that emphasize safety are less likely to do so, with the effects concentrated. on banks focused on competition and control. Specifically, borrowers from competitive banks are significantly more likely to be sub-investment grade borrowers (those with a rating below BBB). In keeping with the fact that these banks are profit oriented, they charge these borrowers a more spread out loan on the safe borrowers, while imposing less covenants on them in the loan contracts. As a result, these banks show higher loan growth in normal times, but incur significantly greater loan losses when the economy is struggling. In addition, using a systematic banking risk measurement, we find that competitive banks exert a significantly greater influence on the instability of the overall financial system. In contrast, control-oriented banks are less likely to extend credit to subprime borrowers. In addition, they reward secure borrowers with lower interest rates and impose more covenants on risky borrowers. While these banks show more conservative loan and earnings growth, they are healthier when the economy faces tough times.
It is important to note that even when we take into account many factors that have long dominated political discussions such as executive compensation, corporate governance, and banking business models, the corporate culture of banks remains a very important explanation of their risky behavior and, ultimately, of the overall stability of the financial system. Our results suggest that banking culture has a major effect on the economy.
Overall, we find that banking culture not only affects the risk-taking of individual banks, but also has far-reaching consequences for the overall stability of the financial system and the economy. Taken together, our results reflect the opinion of policymakers that banking culture does indeed play an important role in influencing bank behavior and systemic stability. So, at the very least, this study serves as a rationale for regulators to make corporate culture their regulatory priorities and it is hoped that our work will provide a better understanding of how corporate culture in the financial sector can influence financial stability. overall.
Vathunyoo (Ben) Sila is Senior Lecturer in Finance at the University of Edinburgh Business School. His research interests include corporate finance, law and finance, and corporate governance.
Duc Duy (Louis) Nguyen is Senior Lecturer in Finance at King’s Business School, King’s College London. Louis’s research interests are empirical corporate finance, financial intermediation, and labor issues in finance. Louis obtained a doctorate in finance from the University of Edinburgh.
Linh Nguyen is a senior lecturer in banking and finance at the University of St Andrews School of Management. His research focuses on empirical banking and finance. Before joining academia, Linh was responsible for the treasury of Vietnam’s first private bank.