Hamid Mehran discusses the recent report on sexual harassment and misconduct at the Federal Deposit Insurance Corporation, highlighting the potential negative impact on financial stability due to the departure of experienced examiners and supervisors. Mehran suggests adopting a clawback scheme in employment contracts for senior employees to foster a healthier work environment and protect the FDIC’s most valuable asset, its human talent.

The allegations of sexual harassment and misconduct at the Federal Deposit Insurance Corporation (FDIC) has been in the new s for the past seven months. On May 7, the FDIC released the report conducted by a third-party law firm investigating the agency’s work condition and culture. It concluded that “for far too many employees and for far too long, the FDIC has failed to provide a workplace safe from sexual harassment, discrimination, and other interpersonal misconduct.” The harsh reality from the report is that sexual harassment and misconduct is present even in a government entity.

What is particularly alarming from the report is that, in this case, the entity is entrusted to establish a safe financial system that impacts everyone. While misconduct cases are horrible in themselves (wrong, immoral, and punishable under the law), the adverse effect of some cases could be far reaching with large consequences on the welfare of the public. In the FDIC case, sexual harassment and misconduct might interfere with the goal of financial stability (and efficient allocation of labor force).

Consider a highly talented examiner or supervisor at the FDIC who cannot tolerate the hostile culture and decides to leave or faces being assigned to a different job if she complains. While examination and supervision are process-oriented, the judgment of a capable person to understand a bank’s complex operations is critical, particularly in the production and assessment of soft information. Further, examiners exercise significant discretion interpreting bank’s health condition. Gaining experience takes time, and experience is an important asset, especially in an institution that is unlikely to be overstaffed to deliver its mandate. According to the report for example, since 2020 an average of 40% of positions in the FDIC’s large bank supervisory staff in the New York region were vacant or filled by temporary employees. Short-term hires are unlikely to be assigned to critical bank examinations and also are unlikely to receive the training needed to perform the task. Thus, the departure of an experienced employee could impose risk to the supervisory mission (according to some senior supervisors at the FDIC and Federal Reserve) , particularly when the leave is not orderly. Although the risk of such a departure on the subsequent quality of supervision cannot be precisely determined, it is not zero. The closest empirical test of this argument is in the audit industry documenting that the turnover of auditors with 4-8 years of experience when turnover is high induces failure of control system over financial reporting. Employees with highly specific knowledge are hard to replace, thus leading to an institution’s failure to satisfy its core mission particularly in complex bank environment.

A work force composed of experienced supervisors, who also could train other supervisors, is a necessity in banking stability. The FDIC identified high staff turnover as a contributing factor to poor supervision of the failure of Signature Bank in 2023. A careful assessment of how much sexual harassment has contributed to high turnover at the FDIC requires detailed data. While the Federal Employee Viewpoint Survey breaks down reasons for departures , it does not ask if the separation was due to sexual harassment or hostile work environment. Thus, it is difficult to fully assess vulnerability in financial stability due to employee departure a result of poor work culture at the FDIC. That being said, the report indicates that over 500 current FDIC employees reported harassment incidence. Also, sexual harassment and misconduct is likely to be more pervasive than the reported cases. According to the report of those who reported having experienced sexual harassment in the survey “38% said they did not report the incident because of fear of retaliation”. Thus, there are likely many others who have not reported and remain fearful of reporting misconduct they have experienced at the FDIC. Further, the independent report suggests the lack of confidence in the FDIC leadership is a reason for work discontinuation at the agency by its employees.

The FDIC leadership could convey the commitment of the institution to its current and future employees to foster a healthier environment for working and serving the public, but will they believe them? Addressing misconduct requires far more than establishing a more effective compliance system. Progress on this hard topic requires a cultural shift and a teamwork approach across the institution.

A potential approach to address misconduct cases is the adoption of a clawback scheme in employment contracts for senior employees. For example, one or more administrators might be asked to forfeit a fraction of their past base pay (or bonuses if exist) if they fail to report cases or address them effectively (for further discussion see Mehran, 2023). The goal of this remedy is to internalize the cost, discipline senior administrators if they fail to follow their institutions’ guidelines proactively, and thus effectively raise the price of rule violations. In aligning their incentives in this way, leaders are more likely to protect not only the victims and the institution’s reputation, but also themselves. Adopting a clawback scheme at the very least could complement the compliance aim if and when it fails to function adequately. Clawback amount does not need to be large for its aim to be effective and the scheme could be cover most income levels as discussed in Mehran, 2021.

Why the FDIC should adopt a careful plan to foster a healthy work environment to serve the public is obvious. The most important asset of the FDIC (and other regulated agencies) is its human talent. Employees are the ones on the ground ensuring that banks are safe. Meanwhile, agency leaders are more easily replaced. Examiners are the most important assets at the FDIC and should be appreciated, and their complaints should be taken seriously. Without good examiners, the United States would need a far bigger insurance fund to clean up its banking problems, with the cost passed on to taxpayers by the banks. The takeaway is that regulators and supervisors should do a better job by improving their own governance. The progress in this front could enhance financial stability and the governance of financial institutions as well.

Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.