1. First of all, I would like to thank 1LoD for inviting me again to address this year’s “XLoD Global”. I am very delighted to share with you all our thoughts and actions on managing conduct risks, which have always been deep in our mind. 
2. 
   

Managing Conduct Risks

2. Since the Global Financial Crisis in 2008, managing conduct risk has become more important than ever for both supervisors and banks. It is rather clear to everyone that hard rules and codified requirements can only serve as the bottom line when we talk about bank culture and behavior of financial practitioners.  Then what are the real drivers behind?  And what are the root causes of poor conduct? 
3. 
   
4. In the promotion of sound risk culture in the banking industry, the Hong Kong Monetary Authority (HKMA) emphasises that there is no single “sound” culture that is applicable to all banks. And we encourage banks to foster a sound culture through focusing on three pillars: strong governance; appropriate incentive systems and effective assessment and feedback mechanism.  Today, I would like to focus on two important pieces in play in shaping the culture of a financial institution – the incentive system and consequence mechanisms of frontline staff.
5. 
   

Focused Review on Incentive Systems

4. Incentive systems have to be fit for purpose. Given the sensitive and proprietary nature of incentive systems, banks generally are unable to share and compare their incentive practices, needless to say how to assess what incentive practices are more effective in driving desired staff behaviour.  With these in mind, the HKMA conducted a Focused Review to deep dive into the incentive systems of front offices in 20 retail banks in Hong Kong, in order to provide some useful benchmarking reference to the industry. 
5. 
   
6. As you can imagine, this was a very large scale industry-wide culture exercise ever conducted in the Hong Kong banking industry, which comprised our first ever industry-wide employee survey, as well as a range of other activities including focus group discussions and individual interviews. The review aims to gauge the inner true voice of the frontline staff who interact with bank customers on a daily basis, and to identify observations common in the industry, plus useful incentive design principles and practices.
7. 
   
8. Let me share with you some very interesting observations. One of which is that good “customer outcomes” are often interpreted by frontline staff as “customer satisfaction”.  When speaking of “customer outcome”, one may immediately think about how satisfied a customer would feel right after the selling process, for example, whether a customer walked away with a smiley face and thumbs up.  But if you think deeper: this “happiness” should not be conveniently taken as good customer outcome.  In fact, good customer outcome should focus on, among others, whether customers are provided with accurate and sufficient information, and whether the products or services provided to the customers indeed suit their needs.  Imagine, if a frontline staff wants to keep a customer happy by skipping all the due diligence procedures, so as to complete a transaction very quickly to save the customer’s time, it calls into the question whether the products or services would really suit the customer’s need.  And consequences would come later when the market conditions turn sour.
9. 
   
10. Another interesting observation is about perception of importance of business achievement. An area that banks have been putting a great deal of effort in the past few years is reducing the weight of financial performance in incentive systems.  It was found in the Review that banks’ leaders generally consider that the incentive systems are now quite balanced between financial and non-financial factors.  Yet the Review noted that frontline staff still think that financial achievement is of utmost priority in their performance assessment.  This reflects that some other forces may be at work.  For example, many bank staff may feel excessive pressure to meet business targets through social recognition of business achievements, and at the same time they may not feel that they are receiving recognition or reward for non-financial performance (such as compliance and customer outcomes).  It comes rather clear that financial institutions should be mindful of such perception gap and the need for reality check. 
11. 
    
12. The HKMA has published the report of this Review in May this year, and the report is definitely worth a read if you wish to find out more. In addition to industry-wide observations and other interesting insights, we have also devised six useful incentive system design principles and 17 sound incentive practices to reinforce good customer and conduct outcomes.  We trust that this industry-wide exercise has provided meaningful and valuable inputs to our banks, as well as other financial institutions. 
13. 
    

Mandatory Reference Checking Scheme

9. Let me now turn to Mandatory Reference Checking Scheme, another important piece of our bank culture efforts.  We realise that regardless of how hard one tries to drive desirable staff behaviour through an appropriate incentive system, we cannot naively assume that staff will always behave with integrity.  The phrase “rolling bad apples” literally means that individuals, who have committed misconduct behaviour in one institution, are able to obtain subsequent employment elsewhere without disclosing their earlier misconduct to the new employers.  In this manner, misconduct risk is transmitted within the system.  Indeed, our peers in a number of jurisdictions have the same aspiration in addressing this phenomenon.  But when “bad apples” try to “roll” from one institution to another, this cannot be easily dealt with by individual banks alone.  It is important for the banking community to work together to collectively tackle the issue and limit the harm inflicted by the “bad apples” on the system.
10. 
    
11. To this end, I am happy to see that the Hong Kong banking industry has been working closely with the HKMA over the past two years, and finalised the Mandatory Reference Checking Scheme in May 2022.
12. 
    
13. Under the Scheme, all banks will share and obtain conduct-specific reference information about prospective employees using a common protocol to support informed employment decisions.  The protocol will cover seven years of misconduct behaviours, including breaches of legal and regulatory requirements; incidents which cast serious doubt on honesty and integrity; internal or external disciplinary actions as well as ongoing internal investigations relating to misconduct matters.
14. 
    
15. We understand that some banks may have concerns about reporting ongoing investigations, for fear of litigation risks. But we don’t want to create a potential loophole such that “bad apples” could just get around the Scheme by leaving one bank to join another once an investigation commences.  To strike a balance, the industry guidelines set out factors that banks should take into account when exercising judgement on whether or not to share information about ongoing internal investigations.  To ensure transparent and fair treatment to the job applicants, they will be provided with an opportunity to be heard in case of any negative information.
16. 
    
17. Phase 1 of the Scheme covering senior positions will formally start in May 2023 after one year of preparatory work.  We look forward to collaborating with the banking industry to ensure smooth implementation of the Scheme.
18. 
    

Closing remarks

14. Ladies and gentlemen, bank culture plays a pivotal role in driving staff behavior, and thus fostering a sound culture is the fundamental key to addressing conduct risk. We have invested a lot over the past few years to promote sound bank culture.  We trust that our culture efforts including the Focused Review and the Mandatory Reference Checking Scheme would set an important milestone in the bank culture development in Hong Kong.
15. 
    
16. I would like to thank 1LoD again for inviting me to talk about our perspective on bank culture today. And I hope very much my remarks will inspire you all to continue your investments in culture of your institutions.