DEI delivers for banks

By Richard H. Harvey Jr. and Francis Janes

In its core function of connecting Americans’ savings with communities’ business, housing and job needs, banking has transformative power to contribute to a more equitable, inclusive and just society. A resilient, transparent and smooth-functioning financial services sector contributes to financial stability, job growth and poverty alleviation. Equitable and fair access to financial services improves a country’s overall welfare because it enables people to thrive and better manage their needs, expand their opportunities, and improve their living standards. When all citizens are financially included, they can manage consumption, payments and savings; access better housing, healthcare and education; start their own businesses; and secure insurance products to protect themselves from shocks and unforeseen events.

We believe that we can only accomplish this transformative work by embracing diversity, equity and inclusion within our institutions. And embracing DEI will not only help banks serve their clients in full; it will also strengthen the DEI-focused bank’s business operations, their regulatory compliance and their ability to attract and retain top talent.

Reinforcing the business case

Many of us know intuitively that diversity is good for business across a number of important indicators. The business case for establishing a diverse workforce at all organizational levels grows more compelling each year. There is substantial research to show that DEI brings many advantages to an organization: better problem-solving capabilities, increased innovation and creativity, stronger governance, more effective talent recruitment and retention, higher levels of employee engagement and likelihood of financial outperformance. In the United Kingdom, greater gender diversity on the senior executive team corresponds to superior financial returns according to McKinsey research. In the United States, there is linear relationship between ethnic diversity and better financial performance: for every 10 percent increase in ethnic diversity on the senior executive team, earnings before interest and taxes rise 0.9 percent, according to the same McKinsey findings. Employees with diverse backgrounds bring to bear their own perspectives, ideas and experiences, helping to create organizations that are dynamic and resilient, and outperform organizations that do not invest in DEI.

Our instinct and common sense should tell us that diverse organizations are more likely to drive innovation and creativity. When a team is made up of people who have a great deal in common, we risk groupthink—a sameness of perspectives that can lead to complacency, stagnation, corruption and even organizational decline. Such homogeneity also inhibits a company’s ability to respond to challenges in a direct and constructive manner. When we are forced to respond to major concurrent challenges such as a pandemic, a global outcry for racial justice, a call for climate action and a deepening polarization of our social fabric, institutions must strive to harness the collective wisdom and lived experiences of those who have been historically marginalized from the decision-making process.

In October 2021, Acting Comptroller of the Currency Michael Hsu said in a speech that for banks, “diversity is also important from a safety and soundness perspective. Without diverse leadership, banks and their regulators may develop blind spots or suffer from group think. These blind spots can lead to the kinds of nasty surprises that threaten safety and soundness—and possibly the financial sector as a whole. There is a growing body of empirical evidence that companies that address these blind spots by having diverse boards of directors have stronger earnings, more effective corporate governance, better reputations, and less litigation risk.”

Organizations equipped with a wide range of backgrounds, voices and perspectives throughout the ranks are better able to innovate, take risks, solve problems creatively, bounce back from failures and turn challenges into opportunities. “The mere presence of diversity in a group creates awkwardness, and the need to diffuse this tension leads to better group problem solving,” says Katherine Phillips of Columbia Business School. “People would prefer to spend time with others who agree with them rather than disagree with them. It’s kind of surprising how difficult it is for people to actually see the benefit of the conversations they are having in a diverse setting.”

Meanwhile, HP Inc. Chief Diversity Officer Leslie Slaton Brown asserts that “[e]mbracing diversity and inclusion infuses organizations with fresh perspectives that inoculate us from the plague of complacency by ensuring that our assumptions always are questioned.”

It turns out that our instincts are correct. We can move beyond assuming the benefits of diversity and back it up with data. A 2017 Boston Consulting Group study of more than 1,700 companies around the world shows that diversity increases the capacity for innovation by expanding the range of a company’s ideas and options, leading to better financial performance. BCG found a strong and statistically significant correlation between the diversity of management teams and overall innovation. BCG’s study observed that companies with above-average diversity on their management teams reported innovation revenue that was 19 percentage points higher than that of companies with below-average management diversity—45 percent of total revenue versus just 26 percent.

In an increasingly complex business environment, a culture of innovation means that these companies are better able to quickly adapt to changes in customer demand and to changes in society. Not surprisingly, these organizations also reported better overall financial performance. BCG’s research found that companies with above-average diversity on their management teams reported EBIT margins that were 9 percent higher than those of companies with below-average diversity on their management teams.

Even with a diverse management team in place, companies will be able to take advantage of the unique viewpoints and perspectives of leaders only if the organization has been successful in cultivating a strong foundation of inclusion. The BCG study therefore looked at the presence of the factors that allow diversity to flourish and help the diverse management team reshape the company’s innovation efforts. These factors include fair employment practices, such as equal pay; participative leadership, with different views being heard and valued; a strategic emphasis on diversity led by the CEO; frequent and open communication; and a culture of openness to new ideas.

A compliance-focused case for DEI

Compliance risk has become one of the most significant ongoing concerns for financial institution executives. Since the Great Recession, regulatory fees have dramatically increased relative to bank’s earnings and credit losses. For the top 20 European Union-based and U.S. global systemically important banks, regulatory fines and settlements increased by almost 45 times over the period from 2009 to 2014, according to McKinsey. The scope of regulatory focus continues to expand. New topics continue to emerge, such as conduct risk, next-generation Bank Secrecy Act and anti-money laundering risk, risk culture and subcontractor risk. Regulatory compliance has undoubtedly affected banks in a variety of challenging ways, increasing the cost of service and sometimes making the delivery of great customer experiences more difficult. However, as the regulatory environment evolves, we see a major opportunity for the compliance function to stay ahead of the curve by implementing targeted changes to its operating model and processes, and thus delivering a better quality of oversight while at the same time increasing its efficiency. Banks with an innovative workforce will enjoy a distinctive source of competitive advantage in the foreseeable future, being able to deliver better service, reduce structural costs and significantly derisk their operations.

The trend toward increased boardroom diversity is gathering pace as boards continue to be under pressure from both regulators and the public. In recent years, gender equality has dominated the diversity agenda in the EU, and much of the debate has centered on the subject at continental and national levels. Different countries have adopted different approaches to boost female presence in the boardroom. Some have set internal targets while others, unsatisfied with slow progress, have resorted to binding obligations using strict quotas to improve female representation on boards. In Korn Ferry’s Non-Executive Directors in Europe 2019 report, survey data shows that 34 percent of directors are female across their European sample. Norway was the first country to mandate a quota, passing such legislation in 2008, and companies risk dissolution if they cannot comply with the 40 percent target for female representation. Elsewhere in Europe, Belgium, Italy and France have legislative quotas with penalties, including fines. Germany introduced a 30 percent quota without sanctions in 2015, while companies based in the Netherlands must “comply or explain” if they don’t hit a 30 percent target.

In August 2021, the Securities and Exchange Commission approved new U.S. listing rules from the Nasdaq Stock Market regarding board diversity and disclosure. The new rules will require a Nasdaq-listed company to have at least two non-white, male and heterosexual directors (including at least one woman and at least one member of an underrepresented community, including racial and ethnic minorities and LBGTQ individuals) or the company will have to explain why it has failed to do so. Subject companies will also be required to disclose board diversity on an annual basis in a prescribed tabular format. Companies with five or fewer board members will only need to have one non-white, male and heterosexual board member (or explain the absence of such a director). In addition, issuers outside the U.S. (i.e., foreign issuers) and smaller reporting companies would have additional flexibility in satisfying the board diversity requirement. Foreign issuers and smaller reporting companies would be able to satisfy the board diversity objective by having two women directors.

Attracting and retaining today’s talent

In our introduction, we noted that organizations with a reputation for a strong culture of diversity and inclusion will likely win the war for talent. According to a 2020 Glassdoor survey, diversity and inclusion is an important factor for most job seekers, but more so for underrepresented groups. More than 3 in 4 employees and job seekers report that a diverse workforce is an important factor when evaluating employers and job offers. About one in three employees and job seekers would not apply to a job at a company where there is a lack of diversity among its workforces. Nearly two in five employees and job seekers would not apply to a job at a company where there are disparities in employee satisfaction ratings among different ethnic/racial groups.

The millennial generation, born between 1980 and 2000, will shape the world of work for years to come. Attracting the best of this cohort is critical to the future of any business. Their career aspirations, attitudes about work, and embrace of technological innovation will define the culture of the 21st century workplace. Millennials matter because they are not only different from those that have gone before them, but they are also more numerous than any since the baby boom generation. Researchers estimate that millennials reached their peak presence being 44 percent of the global labor force as of 2020. As executives from Generation X begin to wind down their careers over the next couple of decades, businesses will compete for the next generation of leaders from the millennial cohort.

Over the past decade, highly educated young professionals have increasingly prioritized personal values in deciding where to work, whether it’s a commitment to climate action, racial and gender equity or LGBTQ equality. Millennials are setting a higher bar and have higher expectations of their employers. These expectations include hiring a more diverse workforce, helping employees of color advance through the ranks, and facilitating uncomfortable conversations about how racism operates. According to the Deloitte Global 2021 Millennial and Gen Z Survey, millennials believe discrimination is widespread and is likely enabled by racism in major institutions. Fifty-six percent of millennials see “systemic racism” as widespread in general society, and 34% of millennials believe it is widespread in the workplace, suggesting that much work remains to be done by both employers and employees to ensure that all groups, regardless of their backgrounds, are treated fairly and with respect. U.S. companies—including banks—have seen documented cases of discrimination against employees, and regulators have imposed severe monetary penalties for those banks who have violated civil rights laws.

Due to a tightening labor market and as a result of more flexible work arrangements resulting from the pandemic, employees have more options and are switching jobs to ones that accommodate a more sustainable work-life balance and for opportunities to advance their careers. To retain their high-performing talent, organizations are focusing on improving their employee experience by fostering employee engagement. The employee experience is the entire journey an employee takes with an organization, beginning with the application process and continuing through to their departure. Employee engagement is the strength of the emotional connection employees feel toward their place of work. Employee engagement can also be viewed as a positive, fulfilling, work-related state of mind that is characterized by vigor, dedication, and commitment. Research published in the Journal of Applied Social Psychology in 2014 suggests that there is a statistically significant relationship between diversity practices and employee engagement at work for all employees.

Because engaged employees are more connected to their workplaces, they’re more aware of their surroundings and issues that might compromise the reputation of their employer. From a banking perspective, a highly engaged workforce is less likely to accept unethical or illegal business practices and the risk of punitive actions from regulators. According to Gallup, 70 percent fewer safety incidents occur in highly engaged workplaces. Since financial services’ frontline employees work with cash and access clients’ confidential information, a highly engaged workforce is more likely to employ best practices that prevent safety or information security incidents.

Beyond the ‘finish line’

Banks are increasingly aware of and in agreement with the evidence for DEI’s positive effects on companies. Banks of all sizes have taken steps toward greater DEI, some more than others and many of them locally contextualized. Institutions that accept the reality of DEI’s benefits for banks—and have begun the work of embedding DEI into their cultures—are already experiencing the benefits.

DEI is not just a good thing to do, it’s the right thing to do. It is not a destination, but it can be a very worthwhile journey. As stated by Christopher Johnson, a member of the Nonprofit Leadership Center’s board of directors who co-leads the NLC’s Diversity Committee, “There is no finish line when it comes to addressing and advancing diversity, equity and inclusion.”

Richard H. Harvey Jr. is EVP, general counsel and director of compliance risk at Beneficial State Bank in Oakland, California. Francis Janes is director of industry relations and partnerships at Beneficial State Foundation.