Corporate Governance and Bank Risk-taking

Research Question/Issue: Bank 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/Insights: We 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 Implications: Prior 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 Implications: Our 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.