4 More recently, supervisors have traditionally addressed firm’s management of misconduct risk by assessing the effectiveness of firms’ risk management and internal control functions, such as compliance and audit. Yet, despite regulations, supervisory focus, and firms’ own efforts, significant misconduct risk and bad outcomes continue. Why? What explains this persistence? One hypothesis is that recent problems are just a stream of idiosyncratic events, random draws of “bad apples.” Another hypothesis is that some firms have operational weaknesses, “bad processes,” that allow these outcomes to occur. I don’t believe, however, that either of these hypotheses tells the whole story. Root cause analyses of many recent cases of misconduct in the financial sector suggest that misconduct is not just the product of a few individuals or bad processes, but rather the result of wider organizational breakdowns, enabled by a firm’s culture. From both a prudential perspective and a financial stability perspective, misconduct risk threatens our core supervisory objective to sustain the efficient provision of financial services to the economy. This suggests that supervisors have an obligation to promote strong internal practices and behaviors that mitigate misconduct risk and create a healthy culture. Misconduct Risk and Cultural Capital One way to think about this is “cultural capital.”5 A firm’s cultural capital is a type of asset that impacts what a firm produces and how it operates.
Kevin Stiroh: Misconduct risk, culture and supervision Remarks by Mr Kevin Stiroh, Executive Vice President of the Financial Institution Supervision Group of the Federal Reserve Bank of New York, at the Culture Roundtable Session with Business Schools and Financial Services Industry, Federal Reserve Bank of New York, New York City, 7 December 2017. * * * Good morning everyone. Thank you for joining us at the New York Fed today and for your ongoing participation in the important discussion around culture and ethics in the financial services sector. This workshop and discussion are a critical part of our ongoing collective efforts on promoting financial industry culture reform. Business schools serve as a major supply source of the talent pool for mid-level management positions in the industry. This relationship makes aligning business education curricula and pedagogy with demands around improving industry culture a mutually beneficial strategy. While your conversation today has focused on the role of academia and industry, I want to take this opportunity to share with you how I’ve been thinking about the role of bank supervisors in the culture reform dialogue. I am the head of the Supervision Group of New York Fed, but my perspective and approach are influenced by my background and training as an economist. You’ll hear me talk about frictions and market failures; about production processes and intangible capital; and the conceptual rationale for a role for the official sector. There are, of course, multiple ways to consider the relationship between culture and bank supervision.