Building a Culture of Compliance

I was scheduled to speak at the AALS Financial Institutions breakfast this morning, but due to flight cancellations I was unfortunately unable to attend. I’m posting below a summary of what I intended to say there, and which I had already planned to share with the readers of Credit Slips anyway. I wanted to talk about what anthropological research among market participants and regulators tells us about how to change the way people behave in the financial markets.  After all, the whole point of regulation is just this–to change behavior. Yet how do you do it?

Of course you can make rules.  There has been a lively discussion on this blog about the value of rules, and I agree that rules have many benefits including their power to signal certain collective commitments: from now on, X behavior is not OK.  Yet rules also have a major disadvantage. Call it the cat and mouse game: as soon as regulators come up with a rule, some market participants start trying to find a way around that rule. For example, as soon as the G20 starts setting new capital adequacy requirements for banks, some investment banks start selling derivatives products that change the look of a balance sheet so that it seems to come into compliance with the new rules.  So then regulators invent another rule to close the loophole. And then market participants find another loophole. And on and on. Lots of wasted regulatory energy.But wouldn’t it be great if we could change the culture of the market–change the mindset of people in the market– so that they would choose to do the right thing all on their own? I mean to suggest that in order for regulation really to work, market participants have to be brought in; they have to feel they have a stake in good outcomes; their view of their own self-interest has to be in line with the larger collective interest.

This is of course the logic behind the idea of tailoring bonuses to long term results rather than short-term results. But one thing you learn from doing qualitative research in the financial markets that will surprise people on the outside is that market participants are not motivated entirely by money.  In fact I would go so far as to say that many of them are not motivated primarily by money. They care about all kinds of things–like having interesting, challenging work, like inventing something new or somehow making a mark that will last, like having meaningful relationships with friends and colleagues and family, like other symbolic forms of rewards ranging from industry recognition awards to academic publications. If this is the case, then bonus reform is a step in the right direction, but it is a pretty limited step.

In my presentation, I intended to talk about how Japanese financial regulators have grasped this point and have sometimes exploited it artfully.  Recognizing that many market participants actually have bigger dreams than a paycheck they have thrown them a line: join us and work with us to fix the market.  Regulators have created prestigious and competitive “fellowships” at the Bank of Japan, Japan’s central bank, for example, where market participants can come to do research, in daily conversation with regulators. The value of these fellowships is that they provide the opportunity for regulators to gather information, and they give both sides a chance to work out creative public-private solutions. But many fellowship recipients come away with an emboldened vision of their larger mission–not just to do well but also to do good, in their own corner of the market.  Likewise, informal “study groups” of academics, policy makers and key market participants serve as a forum for building trust and a shared sense of mission.  When disaster hits, I have seen policy-makers call on these relationships in very effective ways.

One of the lessons economic historians give us about the successes of the early years of the SEC is that the strong culture of professionalism at the SEC gave regulators the confidence, and the skills, to regulate effectively.  But professionalism, confidence and a sense of mission and wider purpose isn’t just for bureaucrats.  It can and does contribute to market stability and fairness in the private sector as well.  The anthropology of markets suggests that it is worth investing in building such a culture.

Anyone interested in more detail can download the slides that I had intended to show during my presentation this morning here.