Network-Sensitive Financial Regulation

61 Pages Posted: 21 May 2019 Last revised: 27 Aug 2019

See all articles by Luca Enriques

Luca Enriques

University of Oxford Faculty of Law; European Corporate Governance Institute (ECGI)

Alessandro Romano

Yale Law School

Thom Wetzer

University of Oxford, Faculty of Law; Institute for New Economic Thinking at the Oxford Martin School; University of Oxford - Oxford-Man Institute of Quantitative Finance

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Date Written: May 13, 2019

Abstract

Shocks that hit part of the financial system, such as the subprime mortgage market in 2007, can propagate through a complex network of interconnections among financial and non-financial institutions. As the financial crisis of 2007-2009 has shown, the consequences for the entire economy of such systemic risk materializing can be catastrophic. Following the crisis, economists and policymakers have become increasingly aware that the structure of the financial system is a key determinant of systemic risk. A wide consensus now exists among them that network theory is the natural framework for studying systemic risk. Yet, most of the existing rules in financial regulation are still “atomistic,” in that they fail to incorporate the fact that each individual institution is part of a wider network.

This article shows that policies building upon insights from network theory (network-sensitive policies) can address systemic risk more effectively than traditional atomistic policies, also in areas where an atomistic approach would seem natural, such as the corporate governance of systemically important financial institutions. In particular, we consider four prescriptions for the governance of systemically important institutions (one on directors’ liability, two on executive compensation and one on failing financial institutions’ shareholders appraisal rights in mergers) and show how making them network-sensitive would both increase their effectiveness in taming systemic risk and better calibrate their impact on individual institutions.

Keywords: Bank Governance, Corporate Governance, Macroprudential Supervision, Network Theory, Systemically Important Financial Institutions (SIFIs), Systemic Risk

JEL Classification: G18, G28, K22, K29

Suggested Citation

Enriques, Luca and Romano, Alessandro and Wetzer, Thom, Network-Sensitive Financial Regulation (May 13, 2019). The Journal of Corporation Law (Forthcoming); European Corporate Governance Institute (ECGI) - Law Working Paper No. 451/2019; Oxford Legal Studies Research Paper No. 43/2019. Available at SSRN: https://ssrn.com/abstract=3387708

Luca Enriques (Contact Author)

University of Oxford Faculty of Law ( email )

St Cross Building
St Cross Road
Oxford, OX1 3UL
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http:/www.ecgi.org

Alessandro Romano

Yale Law School ( email )

New Haven, CT
United States

Thom Wetzer

University of Oxford, Faculty of Law ( email )

Oxford
United Kingdom

Institute for New Economic Thinking at the Oxford Martin School ( email )

Eagle House
Walton Well Road
Oxford, OX2 6ED
United Kingdom

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Oxford
United Kingdom

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