Rethinking Management

Fiasco at Wells Fargo

Other than Trump’s victory in the US election, another story had been developing in the west. It is Wells Fargo, one of the 4 largest banks in the U.S. Wells Fargo CEO, John Stumpf might have been the poster boy back in 2008 when the bank weathered the financial crisis. Banks such as Citigroup, Bank of America, and Goldman Sachs suffered during the crisis and needed the government to inject funding to stay afloat. Wells Fargo, on the other hand, remained unscathed.

Wells Fargo prized its unique ability to gain customer loyalty and cross-sell its products. Stumpf in Wells Fargo 2014 annual report, highlighted that culture counts, and its unwavering focus on the customer. “I have always believed that culture is the most important part of a company’s success. It is the heart of any organization and a significant contributor to long-term performance and stability,” said Stumpf in the annual report.

Wells Fargo’s reputation was so good that a 2015 US News article indicated that it is the best bank stock to buy. Well, Wells Fargo had it all going well and so it seems. This positive image was shredded by a recent revelation. More than 5,000 employees were fired by Wells Fargo after an investigation revealed that they were opening deposit and credit card accounts without permission from its customers in order to meet sales quotas enforced by the bank. According to regulators, as many as 1.5 million deposit accounts and 565,000 credit card accounts could have been opened without customers’ consent.

This was the result of aggressive sales targets, which posed a great dilemma for its employees, either you cheat or you get fired. Employees were under pressure and they reacted in an innovative albeit unethical way – they created fake accounts. This was no single act by an individual, like the spectacular trading loss by Nick Leeson that resulted in the collapse of Barings Bank back in 1995. It must be hard to think that an individual or even a group of individuals would conspire or instigated these acts. Instead, it must be that many employees are facing the same dilemma. Once a so-called solution is found, it became a spreading disease, and it spread to 5000 plus employees no less, and probably became a common malpractice, it became culture. The lesson learnt is this: aggressive targets can be met, but perhaps not in the way you want. Pressure morph people into unpredictable ways.

As a remedy, Wells Fargo decided to eliminate sales goals for all of its retail banking products by January 2017. This decision comes less than a week after the largest US bank reached a deal with regulators and agreed to pay $185m in penalties for its illegal sales practices. Regardless, its reputation had been severely tarnished. Stumpf was replaced. Nevertheless, Wells Fargo remained one of the biggest banks in the US.

Handelsbanken lends a helping hand

On the other side of the Atlantic Ocean, we find a very different bank, Handelsbanken. Like Wells Fargo, it too had stayed clear out of the 2008 financial crisis. But unlike, Wells Forgo, it operates in a very different way. This time, the poster boy was the late Jan Wallander, who just departed this year in 2016. Wallander took the helm in 1970 and introduced a radical decentralization model and a conservative and risk adverse policy to loans. This model propelled Handelsbanken to be one of the most profitable banks for 40 plus years even to this day.

There must be something special in the way in the Handelsbanken model. To Handelsbanken and its clients, “the branches are the bank.” Branches have a high degree of autonomy. This is no cheesy customer focus marketing message. Handelsbanken is dead serious about bringing it to reality. The premise is this: the people closest to the customer are the people at the branch, and hence they know what’s best for the customer. Therefore, the branch should be granted great freedom on how best to serve the customer. With regards to credit risks, branch managers have the best local knowledge about the customer. Thus, pricing is set by the branch. It can offer a different rate for deposits or for loans. It can even offer a price at which the bank does not make money if the staff thinks that it is the right thing to do to maintain a long-term relationship with the customer. Marketing and customer segmentation are also performed at the branch level.

With the focus on branches, one might think Handelsbanken is overly traditional, especially when there is a strong trend towards digitization and customers have other options that visiting branches. Handelsbanken’s rationale is this: While the convenience of a good digital offering is great, customers want to be able to speak to somebody who can make a decision. There is a Handelsbanken app for things like making transfers, but if a customer loses his card, needs a mortgage, or wants to get married, or someone has died, he wants to hear a familiar voice, speak to a familiar person, that is the branch. So, the branch is more like a meeting place to help customers make decisions.

Branches are opened only where the bank can recruit a branch manager who has a good knowledge of the local area and represents a strong cultural fit with the Handelsbanken philosophy. When starting out in a new geographical area, Handelsbanken will open a branch or two, let them run for some time, and evaluate the potential. If results are promising new branches are opened.

Newly recruited branch managers start out with a rather low discretion limit for lending. Each is paired with a Handelsbanken risk officer. Branch managers know that it is bad for their career if they have bad loans, and soon learn how to evaluate the loan quality. Handelsbanken has no department dealing with bad loans. Bad loans are the responsibility of the branch. Thus, risk management is decentralized to the branches. Larger loans involve the review of the loan application by the regional bank, or even the central organization. The intention of the review is not to transfer decision making to more competent people, but to give the regional banks a way to monitor whether the branches are following the bank’s credit policy and applying good judgment. 57% of the loans by number are decided at the branch level, 35% are reviewed at the regional level, while only 8% are also reviewed by the central organization. The branch is firmly in-charge of each loan application, because it not only has the financial ratios about the application but also other qualitative factors which only the branch can judge. The main function of the entire management layer of the regional banks, which are responsible for 25 to 90 branches each, is to supervise and coach branches.

There are no performance targets driven from the headquarters. Neither is performance tied to bonus and rewards. Branch managers are compensated higher than counterparts because they take on greater responsibilities. There are no bonuses, not even for the CEO. However, there is a profit sharing scheme that evenly allocates a portion of each year’s profit to every employee to a fund. Employees can withdraw from this fund, known as Oktogonen, when they reach 60.

Handelsbanken staff enjoy their job and are motivated to do good work even without the promise of a bonus. Handelsbanken relies on internal competition between branches and regions. Performance data such as income:cost ratios (i.e. profitability) are published for all units and especially within groups of comparable branches (i.e. branches of similar size, business mix and age) and then ranked. This internal ranking makes it easy to highlight if someone (branch) is making imprudent loans. So, good quality loans and profitability are the driving factors for Handelsbanken.

It is very obvious that Handelsbanken has an entirely opposite approach compared to Wells Fargo. Wells Fargo drives people through targets, whereas Handelsbanken drives people through doing what is right, and allow them to flourish.

Becoming More Prudent

What we have seen are two very different banks. One is results focused, leading to negative attitudes and behaviors. One is focused on the right behaviors and attitudes leading to positive results. Meeting sales targets were the driving force behind the folks in Wells Fargo, whereas prudent loans as well customer engagement are what drives the behaviors of every branch in Handelsbanken.

Whereas other banks spend tremendous effort on strategic planning and budgeting, Handelsbanken focuses on refining control and reporting tools so that all levels have the right information on a timely basis. Growth and market share are not targets, but by-products. Growth is not a target. It happens naturally. If there is sufficient demand, Handelsbanken opens a branch. Market share is not an objective nor a target. Handelsbanken will willingly lose market share to increase loan quality and profitability. Consequently, it has a rock solid financial standing that has allowed it to grow better than others and weather financial storms.

The current rise of online peer-to-peer (p2p) financial institutions might be seen as a blow to retail banking, especially to Handelsbanken, where the branch is the bank. Nevertheless, a p2p will not lend money to people who otherwise would not get finance. It wants to lend money to those who can repay. That is prudent banking. Whereas online p2p uses data, the physical branch uses customer contact. Regardless, both stress the importance of prudent lending and do not seek volume without first building the sound credit assessment capabilities. Thus, prudence is the key to any form of banking. Two banks having the same loan amount on their balance sheet does not mean that they are equally healthy. It is all about the quality of their loans. On what basis can we decide if a loan to a person is a good loan, that he will indeed repay? Based on his salary? His assets? His track record? Ultimately, his character is all that really matters. The Handelsbanken branch has the insights to evaluate that and therefore is not only prudent but delivers great service.

A bank holds a man’s hard earned savings and has moral obligations to him. The great depression in the 1930s saw the failure of nearly 5,000 banks and mass unemployment in the U.S. Banks took excessive risks and over invested in stocks. The Glass-Steagall act was passed in 1933 to separate commercial banking from investment banking and provided some form of protection for depositors. However, the act was repealed in 1999 to help banks compete with other securities firms. This led to the consolidation of commercial and investment banks that became too-big-to-fail (TBTF). Banks became greedy and once again over-invested. This required their bailout in 2008 to avoid another depression. This coupled with exorbitant and obscene bank CEO bonuses especially during turbulent times makes the man on the street distrust Wall-Street.

Unlike banks that need state regulation, Handelsbanken is self-regulating. Banks compete not only on price and service quality but also on risk appetite. When business is on the upswing, Handelsbanken does not change its risk appetite but remains prudent. This meant that it will lose market share, but this is not an issue. Handelsbanken’s CEO’s bonus does not depend on revenue, and as a matter of fact, he has no bonus. During downturn when other banks are reducing their lending, Handelsbanken’s stable and consistent risk appetite means that they can regain market share at higher margins. Handelsbanken does not play casino, it plays what it is – a bank. It is a stabilizing force, even and especially during a financial crisis.

Thus Handelsbanken plays prudence, doing what this right for both customers and employees. The lesson is this: if we do what is right, then the results will be right. Let rightness directs the results, rather than results direct rightness. This is a return towards the kind of humanity that we hold dear to.

Note: If you are a software professional, then prudence is about writing good code, prudence is about paying your technical debts. Prudence is about being professional and doing what is right.

Becoming More Human

With such remarkable success, enterprises are inspired to imitate or at the least learn from the Handelsbanken model. However, learning is not simply about copying parts of the model. Instead, to really apply the Handelsbanken model, one needs a deep understanding of the underlying philosophy, values, and principles. As Wallander put it, it is all common sense. But all these are uncommon for the imprudent and the impatient.

When Wallander joined Handelsbanken in 1970, it was like any other bank. It was in crisis and turmoil after 100 years of existence. Wallander canceled the centenary celebration and radically decentralized the bank. This was easier said than done because it was too easy to be pulled back towards centralization and command-and-control. There was always a tendency for leaders to intervene to get immediate results. However, Wallander did otherwise. Instead, he chose empowerment.

His underlying values and philosophy are of survival and trust. If a company needs to survive in the long term, it has to be more profitable compared to its competitors. Hence, there are no absolute targets for branches, regional centers, and the central organization, but relative comparison with counterparts. Wallander also introduced a Darwinian survival of the fittest approach within the organization whereby branches compete with each other on the basis of profitability. Data on profitability is transparent and open to all and thus provides an environment of trust. Each branch must experiment and evolve with its environment to survive. It has to understand its customers and the environment which they operate. The branch has the freedom of purpose and the means. The only constraint is prudence and profitability. This inevitably created diversity amongst the branches as they operated in different regions and markets, and facing different customers. Since every individual contributes, it is also only fair to distribute the profits. Since the objective is towards the long term, it makes natural sense to share the profits equally through Oktogonen.

If it is just survival, Handelsbanken might just achieve its goal without the radical decentralization that permeates the organization. However, In addition to survival, Handelsbanken values trust and mutual respect. Again, trust and respect are not some cheesy marketing message. As a matter of fact, Handelsbanken does not believe in marketing, at least not central marketing. Trust and respect permeate in its way it deals with customers and employees alike. To customers, they receive the same treatment as VIP customers are treated in other banks. To employees, it means that the responsibilities are naturally delegated to the branches. We trust you, we help you and we develop you. As a natural consequence, the branch is the bank. Since such a self-regulating mechanism in place, there is no real need for a central budgeting process. Abolishing budgets is a natural consequence. In other words, decentralization is a consequence of trust and respect. Nevertheless, there is still an internal audit process in place to provide an environment to ensure that the necessary documentations are in place. In short, it is trust and respect, but within boundaries. When it comes to recruitment, Handelsbanken attracts employees and customers that share the same philosophy. An organization's philosophy and culture are manifested in the everyday conversations that take place: who talks to who, and the nature of the conversations themselves. Are they more reporting and questioning, or are they more problem solving and collaborating? Are they more about pushing products, or are they more about solving customer’s pain? In Handelsbanken, the answer is very clear. It is about shared values. Shared values between the branches and the centers, between the branches and customers. In this age of individualism and greed, perhaps it is time to return to what humanity holds dear to.

Humanity is about society, about long-term common good. Society is about mutual support. No man is an island; no man is a tool; No man is a mere means, not employees, not subordinates, and definitely not customers. Once good is done, other good things happen. This is what it means to be human.

Becoming More Agile

There is currently a trend towards enterprise wanting to be more agile in software development and in digitization in the face of an ever-changing and complex environment. Although the context of what we have been discussing is banking, what we have been discussing is really more about management and leadership. The Handelsbanken case is a call to the roots of what it means to be human and agile.

We have seen the rise of computing, of software, of the internet, of mobile, of internet-of-things, and of digitization in every sense of the word. Though technology has been advancing rapidly, humanity and hence leadership and management styles have remained fairly constant. There is still a lot that Handelsbanken can do when it comes to digitization and the adoption of technology in general. Handelsbanken is a role model when leadership and management, but definitely not one when it comes to digitization.

Yet so far, more banks have gone bankrupt due to poor management, than because of slow adoption of technology. Whether it was the unexpected Brexit vote, the unexpected Trump’s election victory, or even Wells Fargo’s massive fake accounts, these events pointed out the vast chasm between executives and employees. In their failure to listen, empathize, and correctly respond, leaders and executives found that they lost touch of the ground and hence lost the battle. Blame in on denial or just poor luck, they point to the failure of contemporary management approaches and leadership styles.

The Manifesto for Agile Software Development in 2001, declared that “We are uncovering better ways of developing software by doing it and helping others do it. Through this work we have come to value:  

Individuals and interactions over processes and tools

Working software over comprehensive documentation

Customer collaboration over contract negotiation

Responding to change over following a plan

That is, while there is value in the items on the right, we value the items on the left more.”

Handelsbanken’s approach that we have discussed so far is not about agility in software development or even digitization. Its approach is a certain kind of organization and enterprise agility. It is without doubt that Handelsbanken is still learning and uncovering better ways of banking. Its approach to opening branches is unique. Instead of pushing complex rules and guidelines from the central organization, it chooses to empower and coach branches, and to experiment and evolve. Instead of incurring unnecessary risks, it chose to become better with loan quality and profitability. Instead of strict products and pricing rules, it collaborates with customers to determine what is best for them. Instead of annual budgeting and central planning, it lets the branches and different parts of the organization sense environmental changes and respond accordingly. Handelsbanken is still a hierarchical organization, but the lines and arrows are drawn very differently. The lines do not represent command and control. Rather, the lines represent support and coaching, and they are pointed towards the customer. Instead of merely doing their jobs, employees feel a strong sense of ownership and of service to customers. This is something of envy to many enterprises, not just banks.

Before the Next Crisis

The future of management is a balance of becoming more prudent (i.e. doing what is right), becoming more human (human-oriented, be they customers or employees), becoming more agile (responding to change whilst being stable), becoming more digital (exploiting technology).

It took a crisis in 1970 for Wallander to bring change to Handelsbanken. Since then, its philosophy had allowed it to weather many financial storms and crisis. The fiasco in Wells Fargo had compelled its leaders to rethink the way they manage sales and sales quotas. Handelsbanken is now facing the imminent threat of digital competition. This challenge must be in the minds of Handelsbanken’s leaders.

Even after 40 over years of perseverance, Handelsbanken is still learning. Each CEO is the guardian of the Handelsbanken Way, and writes its own version of the Handelsbanken Way. Beyond that it has developed into a genetic code that is part of every employee. It is its very DNA. Like every species with its own DNA, it develops a kind of immunity. In August 2016, Handelsbanken replaced its then CEO, Frank Vang-Jensen, who had taken on the role for about 18 months. Vang-Jensen seemed to want to control branches from the central organization, which was a clash of principles. In April 2016, He had announced to close as many as over 60 branches over two years. This must have ruffled some feathers to say the least, and he was therefore replaced. The new CEO, Anders Bouvin, stressed that Handelsbanken’s determination to empower its local branches, as a reversal of Vang-Jensen’s approach. He stressed that Handelsbanken’s decentralized business model is a key selling point. He pointed out that Handelsbanken is more customer friendly than the online and digitized services that are starting to dominate elsewhere. Apparently, Handelsbanken is still experimenting and learning. There is still a lot more it has to do. The future is yet to be seen. There is nothing to say that Handelsbanken will not be disrupted in the future. Nevertheless, its approach to decentralization and empowerment is indeed inspiring, to say the least.

Do banks, or for that matter, any enterprise in any industry in general, need a crisis before they change? Notwithstanding, the financial industry has no shortage of crisis. Moreover, the fact that company lifespans are getting shorter. So, these days there is really no shortage of crisis. But with every crisis, comes an opportunity, an opportunity to explore the dark and heinous assumptions that none dared question or even look during the so-called good times.

The advice to leaders is this: there is no better time than now to re-examine the basis of your philosophy. Handelsbanken has indeed a very clear and rigorous philosophy. It is one of prudence, of empowerment, and of experimentation. What is your philosophy? How has your philosophy permeated your organization? How has it driven your enterprise? How will it drive your enterprise to the future? Why are you doing what you have been doing? If you haven’t been thinking or questioning, perhaps it is time to do so now.

Indeed, it is time to rethink management.