The Uncertain Role of Banks’ Corporate Governance in Systemic Risk Regulation

Abstract

This paper examines how corporate governance reform of banks relates to systemic risk. Although there has been substantial emphasis on the importance of corporate governance of banks, it is not entirely clear how this enterprise relates to the goal of financial stability. The first part of the paper differentiates between kinds of risk that arise from the structure of the firm, such as shareholder ownership, limited liability and the separation between control and ownership, and kinds of risk that arise from interactions at the systemic level. It highlights why the risk-taking of banks presents, in many respects, a special case not only because of the structure of their business but also because of recent innovation in the financial sector. It then analyzes how these different kinds of risk are related to each other, showing how firm-level sources of risk are much easier for corporate governance and regulation to address than risk arising at the systemic level. Then, with particular emphasis on recent reforms in the European Union, the paper analyzes policy proposals, including those related to strengthening risk management, altering board remuneration, reformulating board duties and altering the limited liability structure of the firm. The paper concludes that corporate governance reforms have a necessary yet often limited role in the regulation of systemic risk and then relates this discussion to the current state of affairs in the European Union.

Keywords: banks, corporate governance, banking regulation, systemic risk, financial crisis

JEL Classification: G21, G28, G34, K22, K23