Why Cultural Capture Demands a Rethink of Regulatory Basics

Drawing on a research study, Alexandra Chesterfield of the London School of Economics, in her 7 July 2025 article, coined an interesting term in the literature on regulation: “Cultural Capture.”

While “Regulatory Capture” occurs when the regulator, who is supposed to regulate an industry, is influenced or controlled by that very industry, “Cultural Capture” occurs when regulators “unconsciously adopt the worldview, beliefs, and priorities of the very industries they are supposed to oversee.” Chesterfield warns that even well-intentioned supervisors, acting in good faith, may find themselves internalising the assumptions of the institutions they monitor. Not by force, but by default.

“Regulatory Capture” reflects a lack of ethics, as the regulator consciously orients decisions in favour of the regulated entity, even at the cost of public interest, falling victim to lobbying, political pressure or personal gain for employees. In contrast, in “Cultural Capture,” the regulator unconsciously adopts the values, norms, and worldview of the industry they oversee, without direct coercion or bribery. The mechanics behind such a tendency may include long-term interaction, shared backgrounds, or professional networks leading to regulatory subconsciousness aligning with the expectations of the regulated.

Chesterfield introduces the “CHAIN” framework: Closeness, Homogeneity, Avoidance, Identities and Networks, as contributors to a negative transformation with potential to erode supervisory intensity and values. While it does not hinge on misconduct, misalignment accrues invisibly until the institution tasked with oversight no longer sees the need to question what it has come to accept as normal. Changes in regulations, laws, or criminal codes can counter regulatory capture. But the factors that allow cultural capture to take hold are structural and require architectural rewiring and complex design change.

The research finds that regulatory capture has been inadequately identified as the cause of many crises in the financial ecosystem, from the 2008 financial meltdown to the BP Deepwater Horizon disaster, from Wirecard’s accounting fraud to the opioid crisis. When Silicon Valley Bank collapsed in March 2023, the usual finger-pointing was at a genuine regulatory failure. When Credit Suisse imploded around the same time, the familiar refrain of “regulators asleep at the wheel” could be heard. These criticisms, however, missed the deeper problem. Corruption or incompetence were again identified as the villains, but the deeper and more insidious reason was overlooked: cultural capture.

It was not easy to detect. In the 2008 crisis, Fed officials “shared the banking industry’s faith in market efficiency and mathematical risk models. They avoided information from colleagues and outside that contradicted their beliefs about housing bubbles and systemic risk. They saw themselves as partners with banks in promoting financial innovation rather than sceptical overseers protecting the public interest.” Similarly, they did not believe that the basic tenets of managing concentration risks (deposits) and liquidity risks were being ignored. The relationships that should have enabled effective oversight became the very mechanism that undermined it.

Cultural Capture resembles Diane Vaughan’s concept of the “normalisation of deviance”: a process by which deviations from standard procedures or safety norms become accepted over time. Such processes begin with self-rationalisation, become socialised, and are eventually institutionalised. The pattern starts with weakening audit rigour, indifference to early warnings or whistle-blowing, leading to regulatory blind spots and tolerance for shortcuts.

Some of the recent episodes of distress in banks carry signs of such disquieting features. In the case of New India Cooperative Bank, loans sanctioned without due diligence, misappropriation of funds, and poor internal controls were tolerated despite early red flags, until RBI intervened with withdrawal limits and board supersession. Similarly, in IndusInd Bank, misreporting of discrepancies in foreign exchange derivatives persisted for years, until RBI forced disclosure and forensic audits. Even in the Nirav Modi–PNB fraud, signs of cultural capture were evident. For years, two Nirav Modi employees sat daily with a PNB officer in the branch, unnoticed by staff or even the concurrent auditor.

These examples show how “it’s ok” thinking embeds itself into organisational culture, ultimately leading to systemic cracks. Often such negative externalities become so entrenched in an organisation’s ethos that they escape supervisory attention for years.

Chesterfield’s research emphasises that such false narratives influence regulators, who start referring to firms as “clients.” Supervisory language begins to internalise industry logic, leading to the breakdown of the outsider perspective essential for independent oversight. Once that stance is lost, oversight becomes ineffective.

However, such cultural capture does not necessarily involve malicious intent, unlike regulatory capture. It is a by-product of institutional design that shifts supervisory focus away from accountability and towards routine acceptance. Over time, interpretation of warnings and discretionary practices become naturalised as evidence.

There is a need to look at this more seriously. Making cultural integrity a supervisory objective could be the immediate first step. Distress indicators to proactively study cultural leanings should be part of the supervisory agenda, not as moral aspiration but as a governance requirement, subject to audit, oversight, and correction. Finding techniques and tools to capture this will be difficult. Traditional surveys are backward-looking, periodic, and often skewed by cultural dynamics.

The need is therefore to look for AI and ML techniques that can bring real-time, quantitative metrics to dissect qualitative parameters like culture and interpret them in supervisory formats. Further, it would require overhauling organisational governance and supervisory systems to structurally track cultural drift. Organisational culture change over time may be unavoidable and even desirable. But guardrails must be put in place to prevent dysfunction. That will require doing more than reviewing past failures. A fundamental shift in institutional design will be necessary.

In practical terms, the system, both internal audit and supervision, should watch for repeated rule-breaking that is brushed off, treat management responses like “it’s fine” or “we’ve done this before” with caution, and monitor sensitive safety protocols that are routinely bypassed.