Federal Reserve Bank of New York Executive Vice President Kevin J. Stiroh addressed the issue of ‘misconduct risk’—the risk of illegal or unethical conduct by employees at a financial firm—in recent remarks at the Culture Roundtable Session with Business Schools and Financial Services Industry. Stiroh expressed concern that such a risk remained inconsistently addressed across the financial sector, posing a threat to prudential and financial stability.
In a speech titled Misconduct Risk, Culture and Supervision, Stiroh noted that financial firms had lost $320 billion in fines since 2008, a number that could arguably be attributed, in part, to individual misconduct. In addition to fines, he told the roundtable that such misconduct undermined confidence in the financial sector, citing Gallup research in 2016 that showed such confidence had fallen in the prior decade.
He encouraged firms to quantify what he called their "cultural capital." Unlike physical or human capital, cultural capital represents how a firm does businesses. Though he conceded cultural capital was intangible, he argued it was possible to measure and assess cultural capital’s impact. A firm with high cultural capital would see processes that produce results "consistent with the firm’s stated values," rewarding employees who act in accordance with those values. By contrast, he said, a firm with low cultural capital would establish values that "do not reflect ‘the way things are really done.’"
"Employees do not speak freely when they have concerns, and senior managers or the board of directors do not find out about improper conduct until it is uncovered by the authorities," Stiroh said of such organizations. "All of this increases misconduct risk and potentially damages the firm and the industry over time."
Stiroh said the Federal Reserve Banks should use supervision, rather than rule-making, to control misconduct risk. A regulatory change, he said, would be difficult to develop, given the "hard-to-define and evolving nature of behavior" of misconduct.
"Part of the role of supervisors is to close gaps in the rules," he said. "Issues like misconduct risk and culture likely fall in these gaps because they involve the attitudes, norms, and behaviors and suggest a critical role for supervisors in addressing these risks."
