WHY DO BANKS FAIL TOGETHER? EVIDENCE FROM EXECUTIVE COMPENSATION

Recent bank failures have elicited extensive interest about the causes, focusing on incompetence of bank executives, policymakers, bank regulators and supervisors and even uninsured depositors. Yet, before we can prescribe solutions to bank failures, we need to identify the correct causes of the und...

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Bibliographic Details
Published in:Fordham journal of corporate & financial law 2024-04, Vol.29 (2), p.503-559
Main Authors: Anginer, Deniz, Liu, Jinjing, Schipani, Cindy A, Seyhun, H Nejat
Format: Article
Language:English
Subjects:
American history
Arbitrage
Bailouts
Bank failures
Bank management
Banking industry
Capital losses
Deposit insurance
Economic crisis
Executive compensation
Government agencies
Incentives
Insurance premiums
Moral hazard
Regulation of financial institutions
Stockholders
Supervisors
Wall Street Reform & Consumer Protection Act 2010-US
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Summary:Recent bank failures have elicited extensive interest about the causes, focusing on incompetence of bank executives, policymakers, bank regulators and supervisors and even uninsured depositors. Yet, before we can prescribe solutions to bank failures, we need to identify the correct causes of the underlying problems. We argue that the problem is not so much with incompetence of executives, depositors, or regulators per se, but rather with managerial incentives. We provide both a conceptual basis as well as empirical evidence to show that bank executives have incentives to increase systemic risks in order to maximize the benefits of bank bailouts. Consequently, looking at the overall bank risks, although useful, misses an important part of the picture of moral hazard problem. We argue that while bank executives are incentivized to increase systemic risk for the best interest of shareholders, these incentives also exacerbate the problem of financial stability. Thus, any effort to alleviate the moral hazard problem requires an understanding and control of the incentives of bank managers. The mismatch between the cost of the deposit insurance premiums and the benefits of the bailout create an arbitrage opportunity for banks to maximize the net benefits of deposit insurance. We provide recommendations to counteract the distorting effects of bank incentive programs to take on excessive levels of systemic risk.
ISSN:1532-303X