Corporate Governance of Financial Institutions: What’s Special About Banks?

Luc Laeven (IMF)

Keynote LectureDNB Conference, Nov 8, 2012

The views expressed here are my own and should not be interpreted to reflect those of the IMF or IMF Board

Costliest banking crises since 1970s57 55

44 44 44 43 41

32 32 31

Ind

onesia

1997

Arg

entina

1980

Icela

nd

2008

Jam

aic

a

1996

Thaila

nd

1997

Chile

1981

Irela

nd

2008

Maced

onia

1993

Turk

ey

2000

Ko

rea

1997

Fiscal cost(In percent of GDP)

108 103

88 83 8273 72 68 65 63

Guin

ea-B

issau

1995

Co

ng

o, R

ep

1992 Chile

1981

Uru

guay

1981

Arg

entina

2001

Irela

nd

2008

Icela

nd

2008

Ind

onesia

1997

Tanza

nia

1987

Nig

eria

1991

Increase in debt(In percent of GDP)

143130

121109 106 106 106 106 102 98

Kuw

ait

1982

Co

ng

o, D

R

1991

Buru

nd

i 1994

Thaila

nd

1997

Jo

rdan

1989

Irela

nd

2008

Latv

ia

2008

Cam

ero

on

1987

Leb

ano

n

1990

Ecuad

or

1982

Output loss(In percent of GDP)

Source: Laeven and Valencia (2012)

Stealing “other people’s money” “HSBC’s head of compliance quits after money laundering allegations” (Telegraph, July 17, 2012).

“I may like many bankers, but I rather dislike banks. I recognize their necessity, but fear their irresponsibility. Worse, they are irresponsible partly because they know they are necessary. No industry has a comparable talent for privatizing gains and socializing losses. Participants in no other industry get as self-righteously angry when public officials – particularly, central bankers – fail to come at once to their rescue when they get into (well-deserved) trouble.” (Martin Wolf, Financial Times, Jan 15, 2008).

What’s special about banks?

• They are highly leveraged• They have diffuse debtholders• They are large creditors• They are systemically important

• Deposit insurance and financial regulation

I. Limits of traditional corporate governance

• Concentrated ownership• Executive pay• Market for corporate control• Large creditors

II. Bank regulation and systemic risk

• Externalities from bank failures• Bank performance and systemic risk• Regulation and governance interact• Regulatory forbearance

Volatility and correlation of weekly stock returnsLarge and complex US financial institutions, 1980-2011

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1980

1985

1990

1995

2000

2005

2010

Annual volatility of weekly returns of US banks, unweighted average

Correlation of returns

Source: Datastream. Based on weekly stock returns. Sample of large and complexUS financial institutions as defined in Gary H. Stern, Ron J. Feldman, 2004, Too big to fail: the hazards of bank bailouts” Brookings Institution Press, (Box 4.1, page 39).

Regulatory forbearance

• “Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman (Brandeis, 1914)”

• “The only meaningful distinction between man and machine is moral hazard” (Boot and Thakor, 1993)

Regulatory forbearance during crises2

00

2

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

110.4

2.4

4.4

6.4

8.4

10.4

12.4

0.04

0.06

0.08

0.10

0.12

0.14

0.16

Market-to-book value of equity (LHS) Regulatory capital ratio (RHS)

Source: Call Reports of U.S. Bank Holding Companies, Median Values

III. Dealing with systemic risk

• Government ownership• Macroprudential regulation• Capital• Resolution• Government bailouts

The fall of Bankia

0

0.1

0.2

0.3

0.4

0.5

0.6

May 10: Conversion of4.5 bn preference shares

May 25: 19 billion bailout + reinstated 2011 account to 4.3 bn loss

July 20, 2011: IPO at 54% discount

Source: Bloomberg

Bankia’s price-to-book value of equity, 2012

IV. Policy implications

• Bank regulations must be custom designed and adapted to financial governance systems

• Governance is insufficient: Need macroprudential regulation• Enforcement of regulation needs to be

enhanced• Need more capital• Need to improve resolution frameworks

V. Conclusions