Learning Objectives:

• Analyse the causes and consequences of governance failures.

• Identify the factors that can reduce the effectiveness of corporate governance.

• Understand the implications of governance failures for systemic risk.

6.1 Distorted Incentives and Governance Failures

The SOAS module explores “how management incentives in banks can become distorted, and how corporate governance of banks can fail”. The Macquarie University course examines “how subtle flaws in bank regulation can result in a failure of the financial system as a whole”.

Key Factors in Governance Failures:

• Misaligned Incentives: Incentives that encourage excessive risk-taking. The University of Leeds module covers “the interplay between capital regulation and deposit insurance” which can create moral hazard.

• Information Asymmetry: Management having more information than the board or shareholders.

• Regulatory Capture: Regulators becoming too close to the institutions they regulate.

• Groupthink: Lack of dissent and critical thinking in decision-making.

• Weak Board Oversight: Boards that are not sufficiently independent or knowledgeable.

• Short-Termism: Excessive focus on short-term profits at the expense of long-term stability.

6.2 Governance Failures and Systemic Risk

The SOAS module discusses “the factors that can reduce the effectiveness of corporate governance, and explain how this can lead to an excessive level of risk in the financial system”. Governance failures in individual banks can have systemic consequences, as demonstrated by the 2008 financial crisis.

Consequences of Governance Failures:

• Excessive Risk-Taking: Banks taking on more risk than is prudent.

• Fraud and Misconduct: Illegal or unethical behaviour by bank employees or management.

• Financial Distress: Banks becoming financially unstable or insolvent.

• Systemic Crisis: The failure of one bank triggering a cascade of failures.

• Loss of Public Trust: Erosion of confidence in the banking system.

6.3 The Role of the Board in Preventing Failures

The SOAS module uses the UBS case study to illustrate “the relationship between bank strategy, internal governance mechanisms, and oversight”. The case study demonstrates the importance of:

• Independent Non-Executive Directors: Providing independent oversight and challenge to management.

• Board Composition: Ensuring the board has the right skills and experience.

• Risk Oversight: Ensuring the board properly oversees risk management.

• Transparency: Open and honest communication with stakeholders.

• Accountability: Clear lines of responsibility and consequences for failures.