Publications

Abstract

Behavioural risk management (BRM) helps to better prevent risk events that can hurt financial services firms, their customers, shareholders and society. Underpinned by methods and insights from across the behavioural sciences (such as organisational and social psychology, decision making and cognitive science, etc), this forward-looking risk management approach is increasingly encouraged by regulators and invested in by financial institutions globally. This paper provides a practical three-step approach to manage behavioural risk, illustrated with financial services case studies. Future developments are then discussed. The paper closes with common implicit beliefs that may hinder senior risk management professionals initiating BRM in their organisations and a manifesto for action to help get started.

Citation

Scholten, W.W. & Chesterfield, A. (2024). Dear CRO: Behavioural risk management is the new thing for you.  Journal of Risk Management in Financial Institutions, Volume 17, Issue 4. https://doi.org/10.69554/TGJO9623.

Abstract

New legal regimes in various jurisdictions have increased the accountability of senior individuals in financial services to attempt to prevent wrongdoing. This article critically evaluates these efforts using insights from the behavioural sciences research on accountability, the regulatory theory on enforcement, and the criminological literature on compliance. This inquiry is pursued through an analysis of the Senior Managers and Certification Regime (SMCR) and the Banking Executive Accountability Regime (BEAR) in the UK and Australia respectively. These individual accountability regimes (IARs) are designed to make it easier to identify which senior individual is responsible for failing to address wrongdoing within their area of activity. Though often championed for ratcheting up accountability to tackle perceived impunity for wrongdoing, this article explores the limits of IARs. While acknowledging their strengths and merits, it troubles the expectations that such regimes are necessarily effective ways of priming certain anticipated behaviours and increasing cognitive load to slow decision-making processes. It considers the extent to which these regimes may be ineffective given what is known about the miserly nature of human cognition, the tendency to circumvent efforts to encourage ‘right’ decisions, and the inability of individual accountability regimes to address broader structural issues in financial markets.

Citation

McGrath, J., & Scholten, W. (2024). Individual accountability: holy grail or poisoned chalice? Griffith Law Review, 1–25. https://doi.org/10.1080/10383441.2024.2405753

Abstract

Financial services firms have a significant societal responsibility to prevent issues. The three lines model helps them do that though faces challenges in its effectiveness. This paper aims to offer a behavioural perspective on these challenges and practical solutions to help improve the model and herewith better prevent issues. The authors detail key behavioural pitfalls and underlying psychological mechanisms that hinder the effectiveness of the model. The authors illustrate these with examples from the corporate practice, alluding to the behavioural patterns and drivers identified in the academic and consultancy work. The authors conclude with offering practical solutions how to enhance the effectiveness of the model. The authors discuss common ineffective intergroup behaviours between the controllers (here: internal audit) and the controlled (here: the audited business or 2nd line functions): the controllers responding to issues with increased scrutiny; the controlled dismissing the feedback and challenging the issues raised; and the controlled and the controller competing for power. The root causes of these ineffective intergroup behaviours include: psychological defence mechanisms, social categorisation and collective beliefs about intrusiveness. The offered solutions range from actions the controllers can take, actions the controlled can take and actions both can take to improve the effectiveness of the model in practice.

Citation

Fenelon, M., van Doorn, J., & Scholten, W. (2024). Crossing the lines a human approach to improving the effectiveness of the three lines model in practice. Journal of Financial Regulation and Compliance, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/JFRC-09-2023-0150

Abstract

Despite substantial regulatory reform following the 2008 financial crisis, financial firms are still suffering from fraud and other forms of ethical misconduct. As a result, they have collectively paid out more than $400 billion in fines over the past 12 years. A 2019 Harvard Business School study found that among a sample of Fortune 500 companies, more than two instances of internally substantiated misconduct occur each week, on average. It’s becoming increasingly clear that the traditional approach to financial regulation—imposing formal rules and investing in a strong compliance function to ensure that institutions, managers, and employees comply with those rules—cannot protect firms against excessive risk-taking and financial misconduct. The authors of this article draw on their experience advising some of Europe’s largest financial institutions to present an alternative approach to compliance that is based on the principles and discoveries of behavioral psychology. It involves understanding the contextual drivers of human behaviors and introducing small changes, or “nudges,” to eliminate misconduct at the source.

Citation

Scholten, W., de Vries, F., & Besieux, T. (2022). A Better Approach to Avoiding Misconduct: Use nudges to complement traditional methods of risk management. Harvard Business Review, 2022(3), 3-9. https://search.app/wYgHKfC1HpFhisMU9 

Abstract

This book provides insights and tools for managers and in- and external supervisors within financial services that help to define and assess team climates in order to prevent future misconduct. Applying social psychological insights about team conditions that invite unethical behaviour, can help understand and improve current work practices in financial services.

Team climates are a blind spot for banks and financial supervisors. There is much to win by addressing dysfunctional team practices, as a way to prevent future misconduct. In this book I aimed to provide a practical approach to analyse team climate as an internal or external supervisor. I present the ‘Corrupting Barrels’ model that can be used to characterize teams on three aspects that facilitate unethical behaviour: ineffective error approach, outcome inequality and dysfunctional moral climate. By combining a deep dive review including observations and interviews with a survey, it is possible to effectively identify meaningful differences in team climate characteristics that are known precursors of organizational misbehaviour.

The analysis provided is based on data gathered while the author worked as a senior supervisor of behaviour and culture at DNB and provides quotes from board members, senior managers and traders within large European banks.

Citation

Scholten, W. W. (2018). Banking on team ethics : a team climate perspective on root causes of misconduct in financial services. Dissertatiereeks, Kurt Lewin Institute. Retrieved from https://hdl.handle.net/1887/61392

Abstract

This paper aims to identify social psychological root causes of misconduct by traders and offers practical guidelines to prevent misconduct. The authors use insights on social psychological mechanisms to examine current business practices observed in the context of supervisory activities. Case examples were collected at Dutch and European banks, including major institutions. This is an opinion peace that interprets regulator experiences from a social psychological perspective. The authors characterize standard responses to misconduct in trading as reactive and elucidate why this “bad apples” perspective is insufficiently effective. As an alternative, the authors address the social psychological root causes of misconduct within trading teams. The “corrupting barrels” model identifies ineffective error approaches, outcome inequality and dysfunctional moral climates as contextual root causes in team dynamics. The model uses current insights from empirical research in psychology to do so.

Citation

Scholten, W.W. & Ellemers, N. (2016). Bad apples or corrupting barrels? Preventing traders’ misconduct. Journal of Financial Regulation and Compliance. 24. 366-382. 10.1108/JFRC-06-2016-0051. https://doi.org/10.1108/JFRC-06-2016-0051