Dudley Warns Banks to Fix Culture or Be ‘Dramatically Downsized’

Oct. 21 (Bloomberg) — Banks must change the way employees are compensated and take other steps to fix a corporate culture that encourages misdeeds or face being broken up, said William C. Dudley, president of the Federal Reserve Bank of New York.

If bad behavior persists, “the inevitable conclusion will be reached that your firms are too big and complex to manage effectively,” Dudley told industry leaders in a speech yesterday at the New York Fed. “In that case, financial stability concerns would dictate that your firms need to be dramatically downsized and simplified so they can be managed effectively.”

Dudley’s comments, which follow bank scandals involving Libor and foreign exchange trading, were made at a closed-doors workshop attended by senior bankers at the New York Fed on reforming Wall Street culture and behavior.

Large U.S. banks were widely blamed for taking too much risk leading up to the 2008 financial crisis, which triggered the worst economic downturn since the Great Depression.

Lawmakers have since enacted a major overhaul of the rules designed to prevent banks becoming “too big to fail.” Dudley said it was fair to question if the “sheer size, complexity and global scope of large financial firms today have left them ‘too big to manage.’”

Barclays Plc Chairman David Walker, who also addressed the gathering, separately said banks should be allowed to overhaul their own culture, rather than have regulators do it for them.

Deferred Pay

Dudley, who has had to defend the New York Fed recently against allegations it was too soft on big Wall Street firms, suggested a number of ways to better align bank employee incentives with the interests of the general public.

These include deferred compensation plans that switch emphasis to debt, rather than equity, and a centralized, industry-wide registry for tracking individual offenses.

Fines levied against banks could be paid out of deferred debt compensation of senior managers, which would play the role of a performance bond, Dudley said.

“This would increase the financial incentive of those individuals who are best placed to identify bad activities at an early stage, or prevent them from occurring in the first place,” he said, noting that since 2008, fines on big U.S. banks have exceeded $100 billion.

Dudley cited problems associated with complexity at American International Group Inc. and JPMorgan Chase & Co. Differences in business practices across countries also pose challenges, he said, mentioning fines against BNP Paribas SA for U.S. sanctions violations and Credit Suisse Group AG for facilitating U.S. tax evasion.

For lower-level employees, implementation of a “central registry” could help to curb abuses.

“It would be helpful if financial firms, prior to making a hiring decision, could look up a candidate’s ‘ethics and compliance score’ that reflects the individual’s past performance at other financial firms,” he said.

Tough Sell

Paul Sorbera, president of Alliance Consulting, a New York- based recruitment firm, said the proposal would be hard to get off the ground.

“Unless they force everyone to do it, I don’t think it will happen. Why would any firm offer this, it would make it very hard to recruit and retain people,” he said.

Dudley’s remarks followed a speech by Fed Governor Daniel Tarullo delivered at the same conference in which he said banks may face stiffer rules unless they improve their bad behavior.

“If banks do not take more effective steps to control the behavior of those who work for them, there will be both increased pressure and propensity on the part of regulators and law enforcers to impose more requirements, constraints and punishments,” Tarullo said.

–With assistance from Michael J. Moore in New York.

To contact the reporters on this story: Matthew Boesler in New York at [e-mail]; Christopher Condon in Washington at [e-mail] To contact the editors responsible for this story: Chris Wellisz at [e-mail] Alister Bull, Brendan Murray