Internal Corporate Governance and the Financial Crisis: Lessons for Banks, Regulators and Supervisors
24 Pages Posted: 13 Dec 2011
Date Written: December 13, 2011
Abstract
This paper aims to highlight the importance of banks’ Internal Corporate Governance (ICG), viewed as an operational mitigation instrument, in a context where banks enjoy a high degree of organizational flexibility due to principle-based regulatory and risk-based supervisory approaches. The recent crisis has shown, on the one hand, that financial mitigations (i.e. capital requirements) are, per se, not sufficient to ensure the stability of the banks (which underpins the soundness of the entire financial system) and, on the other hand, the failure of the light-touch supervisory approach. The main research question is whether the enhancement of ICG, involving proper protection for stakeholders and the switch to a more intrusive supervisory model, will be able to offset the failures of market discipline revealed by the crisis and, together with Basel 3’s reinforced capital adequacy regime, strengthen the resilience of the financial system, without the reintroduction of structural reforms. In the European Union, the new European Systemic Risk Board (ESRB) and, above all, the three new European Supervisory Authorities (ESAs) will play a crucial role in this process.
The paper is divided into six sections. The first describes the regulatory and supervisory framework for banks and the role of Internal Corporate Governance at the beginning of the crisis. To this end it is of key importance to highlight the specific features of banks’ ICG vis-à-vis non financial firms. The main point is that a principle-based regulatory approach needs, on one side, to be counterbalanced by effective ICG and, on the other, to be backed up by a suitable supervisory model intended to ensure compliance with regulatory principles. In the second section, the main failures and shortcomings of banks’ ICG, as revealed by the crisis, are studied in depth. The most serious weaknesses emerge in banks’ boards, risk management and internal control system frameworks. The third section critically analyses the changes now being made to regulation at the international level with the aim of dealing with the failures that emerged in banks’ ICG. The fourth section highlights some major shortcomings of the new principles issued by the international regulators. The fifth section is dedicated to the present and future role of supervision in controlling the adequacy of ICG as a buffer/protection against the risks taken by banks. The focus is on the working/functioning of the new European supervisory architecture and the consequences of the new system from two main points of view: on the one hand, the national authorities’ role in the implementation and endorsement of EU regulations in general and EU ICG regulation in particular; on the other hand, the degree of intrusiveness of the supervisory models that need to be imposed across the Union to ensure that regulation is really enforced. The sixth section concludes and identifies possible areas of research in this field.
Keywords: banks’ internal corporate governance, financial crisis, operational mitigation, supervisory approaches, European supervisory authorities
JEL Classification: G01, G21, G28, G34, G38, M4, M42
Suggested Citation: Suggested Citation