Laeven, L. & Ratnovski, L. (2014) “Corporate governance of banks and financial stability“, VoxEU Organisation, 21 July.
Bank distress during the recent crisis caused significant damage to the real economy. Appropriately, the policy response focused on stronger bank supervision and regulation. This column asks if there is a role for improvements in bank corporate governance. Based on the literature the authors suggest that better risk management, regulation of pay, and enhanced market discipline can help make banks safer. However, corporate governance cannot substitute for strong supervision: it can at best provide a helping hand.
Corporate governance is the practice of shareholders exercising control over managers so that they act in shareholders’ interests. In non-financial firms, this maximises firm efficiency. Such efficiency effects also exist in banks. For example, banks that face more active takeover markets are more cost-efficient (Brook et al. 1998).
Unlike non-financial firms, bank operations have another relevant dimension besides efficiency: risk. Banks are prone to risk-taking, due to:
- their high leverage,
- limited creditor market discipline (a consequence of deposit insurance and too-big-to-fail guarantees), and
- the ability to rapidly and opaquely increase the risk of assets by changing the investment strategy.
Relevant posts:
- Mink, M. & de Haan, J. (2014) “Spillovers from systemic bank defaults“, VoxEU Organisation, 24 May.
- Ignatowski, M. & Korte, J. (2014) “Resolution threats and bank discipline“, VoxEU Organisation, 20 May.
- Bauer, M. & Demary, M. (2014) “European Banking Union: Status of Implementation and the Need for Improvement“, Konrand Adenauer Stiftung, 23 April.