Organizational theory in the context of principle-based regulation

Modern global financial services are inherently risky undergoing high regulatory pressure because their corporate culture must be embedded in well- functioning risk-based frameworks. The emphasis is put on risk assessments when the employees of the first line of defense are to explain clearly to local regulators what their risks are, what their controls are and what their mitigation actions are. Risk assessment as a whole has become extremely important in recent years because the fight against the Financial Crime has taken a more holistic approach with regulators emphasizing a Risk-Based Approach (RBA) everywhere where the financial institution is interacting with the customer. For most global companies, the implementation of the RBA inside of multiple business lines is a contemporaneous challenge. But when we consider its core element, it is all about the idea related to the organisation that works together and is capable to transform itself for achieving a desired outcome. Consequently, let us reflect on the historical background of this challenge.

Max Weber, and Frederick W. Taylor were two classical authors on organisation sociology and understood the term organisations as being closed and rational systems, which use consciously and in a planned way financial and human resources in order to achieve a maximum economic success (Morgan, 1998:17-33).  Both in Weber’s bureaucracy’ theory and in Taylor’s scientific management theory, the machine metaphor approach was central put a predominant importance in maximizing organisational effectiveness (Dessler, 1980; Morgan, 1998; Smither, 1994).

As a matter of fact, the organisation was understood as a machine or as an instrument to achieve given goals operating in a coordinated way (Smither, 1994).  This metaphor was based on the assumption that effective work planning could only be achieved by high-grade division of labor and by a taut control system (Spaltro, 2002:55).  Therefore, the machine perspective approach described by Weber and Taylor was based on the assumption that “humans are homo oeconomicus“, meaning that employees’ motivation was money, and they were uninterested in the content of their activity (Hofstede, 1997:63; Spaltro, 2002:53-57).

Nevertheless, a reorientation from the machine perspective approach was initiated by the human relations school movement in the 1920s, taking into account social-psychological human needs (Morgan, 1998:17-37). The representatives of this movement focused on the importance of the attitudes and feelings of workers, stating that informal roles and norms influenced business performance.

Consequently, a new concept of organisational culture led to the replacement of the outdated classical field moving towards the analysis of norms/standards as well as values stressing the importance of social needs. According to Morgan (1998:37), such a shift started in the 1930s with Elton Mayo’s “Hawthorne Studies”.  The object of his research shifted from that of an organisation ‘as objective reality’ to the view on the organisation as a sign of the process of the construction of reality.  Humans acted therefore as creators of values, norms/standards and symbols (Schein, 1992:126; Spaltro, 2002:59). Thus, an organisation was understood as a miniature company, which developed its own characteristic culture.

As noted by Spaltro, organisations are examples of social systems whose components constantly interact with their environment (2002, 100). Morgan (1998) goes even further by comparing organisations to organisms, which are open to their environment and must achieve an appropriate relationship with that environment if they are to survive (Morgan, 1997:39). Finally, the term organisational culture has defined the whole of the organisation-referred values and standards.  Therefore, organisational culture is the result of a historical process, which has been shaped by human decisions and actions (Schein, 1992:51).  The picture of people as “homo oeconomicus” has been replaced by that “homo sociologicus”, in which social relationships play an important role (Spaltro, 2002:53-57).


Geert Hofstede (1928)
Picture credits: Wikipedia

In conclusion, it is necessary to underline that Weber-Taylor’s formulation of the organisation as an objective reality is hardly adaptable with the modern concept of the organisational culture (Schein, 1992:126).  An organisation is not an objectively existing world being independent from the persons acting within it but rather it results from the analysis and interpretations of its involved members (Gibson et al., 2003:7).  In this historical context, it is now understandable why with the advent of the risk-based approach, regulatory focus in Switzerland has been placed on principle-based regulation where FINMA puts emphasis on the way in which a firm interprets a set of fundamental legislative principles. These principles will apply to all activities of the firm and are quiet generic in nature, but they oblige the firm itself to determine how the principles are met through its day to day activities providing FINMA with clear explanations on how the desired outcomes are met for the consumers. Principle-based regulation can be viewed as an example of the “social reality which is interpreted by the individuals in each organisation in a different way” (Morgan, 1998:38), or, as it has been once stated by Hofstede: “culture is learned, not inherited” (1997:5). Compliance and risk management culture add value to modern organisational theory and to principle-based regulation.

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