Corporate Governance and Bank Risk‐taking

Abstract

AbstractManuscript typeReviewResearch Question/IssueBank governance has become the focus of a flurry of recent research and heated policy debates. However, the literature presents seemingly conflicting evidence on the implications of governance for bank risk‐taking. The purpose of this paper is to review prior work and propose directions for future research on the role of governance on bank stability.Research Findings/InsightsWe highlight a number of key governance devices and how these shape bank risk‐taking: the effectiveness of bank boards, the structure of CEO compensation, and the risk management systems and practices employed by banks.Theoretical/Academic ImplicationsPrior work primarily views bank governance as a mechanism to protect the interests of bank shareholders only. However, given that taxpayer‐funded guarantees protect a substantial share of banks’ liabilities and that banks are highly leveraged, shareholder‐focused governance may well subordinate the interests of other stakeholders and exacerbate risk‐taking concerns in the banking industry. Our review highlights the need for internal governance mechanisms to mitigate such behavior by reflecting the needs of shareholders, creditors, and the taxpayer.Practitioner/Policy ImplicationsOur review argues that the relationship between governance and risk is central from a financial stability perspective. Future research on issues highlighted in the review offer a footing for reforming bank governance to constrain potentially undesirable risk‐taking by banks.