The activities of the House of Lords are very much in the news at the moment. But the members do carry out serious work, not least on the economic affairs committee. Last week, Lord Green, former chairman and chief executive of HSBC, appeared before them. Yes, the noble Lord admitted, the bank had not got everything right. “There were things we should have done differently with the benefit of hindsight”, he told the committee.
This sort of apology has become routine from those who led banks in the run up to the financial crisis. What was certainly not routine was Lord Green’s view on how the board could obtain reliable information about what was really going on inside the bank. He was nostalgic for what he called the ‘old’ HSBC before the takeover of the Midland in 1992. Then, he said, “you could rely on the people on the spot because you knew them, and had probably been to school with them”. Rather disappointingly, at a time when the Prime Minister likes to surround himself with old school chums, Lord Green himself only went to Lancing rather than to Eton.
But his rather throwaway remark does raise an issue of fundamental importance for all large organisations like HSBC. Just how does the board find out whether managers are cutting corners in order to meet profit targets? Indeed, are the profits which are being reported fair and true? The directors of Barings were certainly duped by Nick Leeson and lost their bank as a result.
Lord Green longed for the days when he had been to school with key people reporting to the board. That is certainly one approach to obtaining sound information. Stalin adopted a similar method in order to know what was actually being produced in the Five Year plans of the old Soviet Union. He believed Nikolai Voznesensky to be completely reliable and promoted him to run the entire Soviet economy when still in his thirties. Voznesensky did indeed provide years of loyal service, though his first slip up was his last. He was shot in 1950.
Boards can’t liquidate employees who distort the information which flows up to them. Yet even this measure, which an economist might regard as providing the ultimate incentive to behave properly, does not seem to have worked. So much depends upon the internal culture of an organisation, as the long and interesting discussion between Lord Green and the members of the economic committee makes clear.
Recent innovations using modern computer science might help. For example, the emotional content of internal emails and communications can be extracted using advance textual analysis. Potentially risky attitudes might be detected, even though the reported numbers tell a different story. Perhaps even more powerfully, by the use of network theory, the patterns themselves can reveal anomalies, regardless of the content of the messages. The Enron internal email traffic has been dissected in a number of academic papers, and the problems were certainly identifiable in advance. At heart, however, it is the culture, the human factor which matters, and it is here where many banks have yet to clean up their acts.
As published in City AM on Wednesday 29th July 2015