Assembly of a conduct risk regulatory model for developing market banks

Abstract

Background: The substantial penalties imposed on banks in the recent past for various conduct irregularities have given rise to a new type of risk called conduct risk. Conduct risk comes about when financial services companies conduct themselves in an inappropriate way towards their customers, resulting in a negative (economic) outcome for the customer. What makes the management and mitigation of conduct risk by banks so different is that it cannot be easily integrated into a bank’s standard risk management framework. So far, the concept of conduct risk has not been formally covered by the Basel Accords.

Aim: There are, however, global efforts by international organisations and local regulators to control it – with little clarity on the ‘how’. The aim of this study is to explore this ‘how’.

Setting: While regulators need to protect customers, resulting in a positive outcome for the customer, they must also ensure that banks take conduct risk management and its mitigation seriously. At the same time, any regulatory model for conduct risk needs to be incorporated into the existing bank regulatory strategy and methodology and assimilated with the profile of a country.

Methods: An exploratory model that regulators could use to keep conduct risk at bay is developed based on primary and secondary data and this is then applied to the South African, Kenyan and Malaysian milieus to determine what can be learnt about conduct risk in emerging economies.

Results: The model investigates the interrelationships between different goals that regulators ideally need to achieve and the findings show that regulators have a difficult task balancing these goals and at the same time achieving a positive outcome.

Conclusion: Based on the model, the recommendation for regulators in the developing world would be to collaborate in their approach to conduct risk, as they might face similar difficulties and operate in a comparable context.