The impact of employee misconduct extends beyond the individual and can impact the firm as a whole, as well as the economy and financial markets more broadly. That is, misconduct risk has both prudential and financial stability implications. For a firm, employee misconduct can make it less resilient by diverting management attention, by harming the firm’s reputation in a way that impedes its business, by driving adverse change in the composition of the workforce, or by depleting its capital through losses or fines. Since 2008, 1/5  BIS central bankers' speeches  for example, firms have paid, in aggregate, in excess of $ billion in fines related to misconduct.2 For the broader economy and financial markets, misconduct can inflict harm directly on consumers and employees. In addition, over time, market participants may lose confidence in the financial sector as a whole and adversely impact the sector’s critical role in financial intermediation. In 2016, for example, Gallup found that confidence in the financial sector had fallen by half over the previous decade.3 These incidents of misconduct can introduce frictions and raise the cost of financial intermediation, which in turn, reduces the flow of productive financial services. These sorts of external effects that spill over to other firms, consumers, and businesses are a critical rationale for official sector intervention related to employee misconduct. In the U.S., official sector concern with the damage inflicted by employee misconduct dates back to the Banking Act of 1933.
Role of the Official Sector These are some of the types of market failures that may explain why a firm might not invest enough in its cultural capital to mitigate risks, including misconduct risk. And they suggest a role for the official sector to encourage resiliency, including investment in cultural capital, beyond what the firm would choose to do on its own. That is, if firms don’t have sufficient incentives to overcome these forces, then the official sector should push toward a better outcome. In the case of misconduct risk, supervision seems like a particularly appropriate approach because the hard-to-define and evolving nature of behavior likely prevents easy regulatory solutions.9 Though some rule-writing could help re-align incentives, misconduct risk can take many different forms and, by its nature, seek to circumvent the rules. Essential drivers of culture and of misconduct risk, for example, relate to leadership and “tone from above,” areas that are inherently behavioral and qualitative in nature. Supervisors can assess behaviors in an ongoing manner and help to identify potential risks.10 I’ll note that the need for a supervisory focus on employee misconduct and its underlying drivers dates back one and a half centuries to the origins of bank supervision. Then, in the U.S., the emphasis was on the “responsibility and integrity” of bank managers and directors and its relationship “to public confidence.”11 Part of the role of supervisors is to close gaps in the rules to advance safe and sound banking practices that support the sustained provision of financial services.