The Role of Risk Management in Corporate Governance

Abstract

Failures of banks’ governance and risk management functions have been identified as key causes of the 2007-2008 financial crisis. This article reviews the empirical literature that investigates the relationship between governance structures and risk management functions as well as their impact on banks’ risk-taking and performance. I first discuss risk management’s responsibilities and relevance for a value-maximizing bank. The business nature of financial institutions and their funding structure, together with explicit and implicit government guarantees, set them apart from non-financial firms. I argue that conventional governance structures alone may be unable to restrain risk-taking in banks and thus the presence of a strong and independent risk management function becomes necessary to monitor and control enterprise-wide risk exposures. Recent evidence shows that a strong risk management function, compatible with the appropriate business model and culture, can restrain tail risk exposures at financial institutions and promote long-term value maximization.