When banks fail, executives should have skin in the game
COMMENTARY
About a year ago, three high-profile regional banks failed, raising long-familiar questions about the resiliency and strength of our financial system. While there were disagreements about the role that supervisory lapses and monetary policy played in the failures, there was consensus that these three banks were grossly mismanaged, failing in the most basic lessons of Banking 101.
For a time, as is often the case, it looked as though
Now, even as the risk of additional bank failures looms, this legislation languishes before the full
It needs to act.
Executives of all three failed banks added low-yielding securities and loans to their balance sheets even when it was clear interest rates would rise, causing those assets to lose substantial market value. The executives failed to effectively hedge that risk, while also relying heavily on unstable, uninsured deposits which were too large for
Most egregious were senior executives at
Those costs are now being made up through assessments on other
The
The bill passed the Banking Committee by a vote of 21-2, with statements of support from its Democratic chairman, Sen.
But unlimited liability was the norm for bank executives during much of the 19th century, and this did not deter quality individuals from entering the banking profession. Instead, unlimited liability for bank executives inspired the kind of trust which in turn brought in more investors and depositors.
To be sure, there were lapses in regulatory oversight of the three banks that failed. But bank examiners are not in day-to-day control of the institutions they supervise. Even the best examiners will not always be able to prevent failures caused by inept management. Regulators also impose capital requirements on banks to give shareholders incentives to monitor for risk, thus reducing insolvencies and the need for government bailouts. However, as outsiders, most bank shareholders have no direct control or influence over management decisions beyond selling their shares.
Management insiders, however, do have the information and decision-making authority to make sure a bank is properly run. The Recoup Act's expanded liability gives them a significant personal stake in their banks' survival.
It creates an elegant alignment of their incentives with prudent risk management, an important supplement to bank supervision and capital requirements.
Serious challenges remain for the
Bank managers need to be more strongly incentivized to prioritize safety and soundness over reckless risk-taking in pursuit of short-term profits. Though executives of
Even with the Recoup Act, some banks might still fail. But by forcing culpable bank executives to have more skin in the game, the Recoup Act should significantly reduce the number of failures.
And if that happens, the public can take some satisfaction in knowing that the persons responsible will be held to account.
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