Banking regulation is primarily concerned with the issue of excessive risk-taking by banks and other leveraged financial institutions, which can result in bank runs and panics, with high economic costs. In recent decades, regulators have almost entirely sought to limit bank risk-taking through external “safety and soundness” regulations that emphasize capital requirements, disclosure, and an intensive examination process.
Financial service regulation, both in the Philippines and abroad, has largely ignored investment banks and other types of financial institutions’ internal governance. Surprisingly, this is still true in the aftermath of the pension fund, which seemed to highlight the shortcomings of relying solely on external regulatory constraints.
Policymakers have primarily considered financial institution governance through the lens of the corporate governance literature, which focuses on shareholder agency costs and generally promotes solutions that best align manager and shareholder interests.
Shaped from the history
The convergence of corporate governance and financial institution governance is largely the result of historical happenstance rather than a deliberate policy decision. Beginning in the late nineteenth century and increasing over time, an increasing number of commercial banks became divisions of investmbank holding companies (which are typically structured as corporations).
In addition, as part of the development of the so-called “shadow banking system,” much of the economic activity of banking has moved off the balance sheets of banks (or bank holding companies) in recent decades. Because of this historical evolution of Philippine banking, the governance of financial institutions includes distinct from and distinct from the governance of other types of business structures such as credit unions, real estate, and central banks has been largely ignored over time, with most scholars preferring to focus instead on corporate governance.
A number of significant and far-reaching changes to safety and soundness regulation, but only a few minor changes to bank governance, such as provisions requiring increased disclosures.
About executive compensation (including “golden parachute” payments), non-binding shareholder votes on executive compensation increased proxy access, and “compensation” mandates requiring corporations to develop and enforce policies that would take back incentive based compensation.
These assessments all address the issue of administrative wrongdoing and seek to better align the incentives of financial firm executives and shareholders. In this regard, the experts’ reforms are consistent with the corporate governance literature, which generally focuses on shareholder manager agency conflicts and emphasizes the importance of shareholder interests.
However, several characteristics unique to financial institutions may render the shareholder primacy norm improper for financial institution governance. First, banks and financial institutions are highly leveraged, which heightens creditor shareholder conflicts in institutional investors and suggests that creditor interests should be given more weight.
Second, the government insures the vast majority of financial institution debt liabilities (either explicitly, as with deposits in insurance companies, or implicitly, as with “too big to fail” guarantees), transforming creditor shareholder conflicts into taxpayer shareholder conflicts.
Finally, because bank failures can cause financial crises, which incur huge costs that are not borne by bank stakeholders, the shareholder primacy logic may be improper for financial institution governance, insofar as it ignores the large negative consequences of bank failures that are not borne by bank stakeholders.
Proposal for Addressing the Problem
The potential misalignment of shareholder interests and public policy objectives has not gone unnoticed by financial institutions. A small but growing number of academics have proposed various mechanisms to address this issue.
There are different types of solutions available internationally:
- Frederick Tung’s proposal to compensate bank executives with squashed debt-based compensation,
- A proposal by a group of leading economists to defer a portion of united states bank executive pay and only pay it if the bank has not declared bankruptcy or received a government bailout.
- Claire Hill and Richard Painter’s suggestion that executives be held personally liable in the event of a bank’s insolvency is an example of the latter approach.
- Dodd-954, Frank’s which requires financial institutions to develop and implement “clawbacks” that deduct executive compensation in the event of an accounting restatement.
- The basic idea behind this approach is to boost financial institution managers to act integrated into the interests of all stakeholders of the firm, rather than just representing the more narrow interests of shareholders.
Additional Approach to the problem
- There is an approach to realign managers’ interests by encouraging them to act in the best interests of regulators. These could be carrots or sticks. Examples of the former approach include Lucian Bebchuk and Holger Spamann’s proposal to tie bank offered executive pay to a portfolio based on the company’s overall mix of federal reserve and debt issued.
- The second approach seeks to alter the incentives of financial institution shareholders by increasing their liability. In the pre-Depression era, shareholders of vault institutions in most states faced double liability, meaning that if the institution went bankrupt, they would owe an amount equal to the par value of the shares they had purchased.
- Some have argued for a return to such a regime, such as Jonathan Macey and Geoffrey Miller, Richard Grossman, or, more recently, Richard Ridyard and Peter Conti-Brown, in which financial institution shareholders face greater liability in the event of insolvency.
- Steven Schwarcz proposes a change in the guardian duties owed by directors of systemically important financial institutions, in which they would owe a “public governance duty” in addition to their existing guardian duties. The goal of this solution is to try to align the behavior of financial firm directors with public policy priorities while providing them with broad flexibility to implement various types of risk-control mechanisms and mutual fund.
Corporate governance in banks effectiveness is determined not only by rules and their enforcement but also by the firm’s ethics and culture. This explains the emphasis on culture in the cross border corporate governance debate, emphasizing the roles that ethics and relevant monitoring play in the financial services sector.
As a result, future research on financial institution governance should not be limited to legal and economic analysis, but should also consider the role and impact of culture and ethics in financial firms from a broad social sciences perspective. In this way, psychology will help us understand the “informal constraints” that govern the behavior of financial institutions offer to supplement their regulation and supervision.