Your InFinance Publication

FINSIA’s InFinance keeps you up-to-date and in-the-know. 

The results are in on a risk culture experimental study across Financial Services…

by Bernard Kellerman | 11 Aug 2017
A study of risk culture across the financial services sector by a team of Macquarie University researchers has demonstrated that profit-based incentives can adversely impact compliance. The results are in on an Experimental Risk Culture Study across Financial Services…

Associate Professor Elizabeth Sheedy, who led the study, said it was designed to replicate real-world investment decisions under a variety of risk scenarios, and is the first of its kind to be conducted in Australia.

“The results of this new experimental research into risk culture sheds light on the compliance behaviour of financial professionals.  It reveals the impact of incentives and how signals from managers and co-workers affect organisational culture,” Dr Sheedy said.

“The key finding of the study is that when staff incentives are linked to profits, rates of compliance with risk management policies fall.”

This article draws on several key findings of the paper, along with further input from Dr Sheedy and FINSIA, to explain the implications of this work for the finance sector.

Real world experience in a lab

The experiment run by Dr Sheedy involved over 300 financial services executives – all members of FINSIA. It was set up so that some participants received fixed payments, while others were offered incentive payments, with all ultimately receiving more than $100 each.

Dr Sheedy said one part of this experiment was to test what it takes to shift the balance between risk management and profit. 

"There's always been an expectation that the business will make a profit but what's new is that, in the last few years, there has been an increased focus on risk management. These days everyone is considered a risk manager so everyone will have certain policies to comply with," Dr Sheedy said.

For example a trader has trading limits; all employees have rules on cyber security and how to deal with email attachments. For the banks it could be reporting suspicious transactions.

“To ensure it was based on real life scenarios, the participants had to do some simple analysis (with a calculator) and then decide whether to invest. During the one-hour lab session, they could invest in up to 60 transactions.  The experiment also reflected the industry context where the participants were given a risk policy and limits to follow,” she said. 

Risk culture and compliance 

The other dimension was to introduce variations in risk culture – that is, how the managers and co-workers behaved in the fictional firm to which the participants were assigned.

"There's a fundamental tension between profit and risk management compliance, but the way these differences are managed are not always consistent. We are social creatures, so we adapt our behaviour. If there is a perception that no one else is complying with the risk management guidelines, new staff will follow their lead."

Dr Sheedy and her team confirmed that risk culture is indeed an important determinant of compliance behaviour, which is in turn effected by incentives. In other words, an emphasis on profit-based incentives is bad for compliance and the effect is reflected in the workplace risk culture.

"It's easy to comply with policy when everything is going smoothly. We tried to see what would happen when pressure points were reached such as when the team was falling behind budget – would they let their risk management obligations slide?" Dr Sheedy said.

Looking at the results from this angle – combining a multipart series of questions developed by Macquarie with behaviour observed during the simulated investment decision session – it was clear that personal attitudes to risk management and compliance are a significant determinant of compliance behaviour. 

"This finding has implications for the screening of job candidates, such as considering candidates’ attitudes towards risk management in recruitment/promotion decisions," Dr Sheedy reported.

Bring on the robots

There is also a place for some automation of investment decisions. 

"When we reduced the burden of calculations on participants we noticed an increase in compliance with risk policy. This is probably because people are less able to resist the temptation to breach policy when they are tired," Dr Sheedy said.

"This suggests that to increase risk compliance it is important for the industry to take better account of cognitive load — i.e. to automate analysis where possible and design work patterns in such a way that staff are not unduly depleted when making crucial decisions."

The profit motive questioned

Profit-based incentives are often used in financial services to encourage effort and boost profits. 

"In our study profit-based incentives did not significantly boost the number of profitable investments. 

"Given the significant adverse impact on compliance noted above, the study supports the elimination of profit-based incentives currently being debated within the financial services industry," Dr Sheedy wrote.

This type of research, a melding of real-world expertise with academic rigour, is a much-needed circuit-breaker at a time when the sector is under pressure to re-invent itself. The issue of properly funding such crucial research is sure to be raised, in the light of ongoing scrutiny of the financial services sector.

Chris Whitehead, FINSIA's chief executive officer, said, “It is very evident that the key results of the study support the careful consideration of profit-based incentives currently being debated within the financial services industry and as reviewed recently in the Sedgewick report released by the Australian Bankers Association."

Access the report here


  • | Aug 13, 2017

Share this