Study: Sanctioning Negligent Bankers
If the negligence of bank executives leads to bank failures or bailouts, those executives should face civil monetary penalties, according to a new University of Michigan analysis.
"This article brings together our wide range of expertise in proposing a targeted solution to tackle the problem of moral hazard in banking and improve financial stability," said Jeffery Zhang, assistant professor at the Law School.
Looking at the near-banking crisis of 2023 following the collapse of Silicon Valley Bank, Zhang and colleagues argue that existing regulatory proposals-such as enhanced bank supervision, tighter regulations and expanded deposit insurance-are insufficient to prevent future failures.
Instead, the study's authors advocate for combining them with a more direct approach: holding individual bank executives financially accountable for negligence that substantially increases the risk of a bank failure.
"By imposing civil monetary sanctions, our proposal aims to realign executive incentives and mitigate reckless risk-taking," said Kyle Logue, professor at the Law School.
The researchers specifically propose a framework that would apply financial penalties to executives at all U.S. banks-whether publicly traded or privately held-when their negligent actions significantly contribute to a bank collapse or require emergency government intervention. Their recommended sanction is a clawback of up to five years' worth of total compensation, with enhanced penalties for gross negligence or misconduct.
"If executives know they could lose years of compensation for reckless decision-making, they'll have a much stronger incentive to act responsibly," said Will Thomas, assistant professor at the Ross School of Business. "This system is designed to deter risky behavior while avoiding the impracticalities of criminal prosecution."
The authors suggest several ways that Congress and regulators might design and implement this sanctions regime. One option is for Congress to amend the Federal Deposit Insurance Act to strengthen sanctions provisions and lower the burden of proof for enforcement. They also recommend restricting directors and officers insurance, or D&O, from covering these penalties to ensure that executives personally bear financial consequences.
Additionally, they propose empowering private actors, such as whistleblowers or shareholders, to initiate enforcement actions against negligent bankers, increasing accountability beyond traditional regulatory oversight.
The article will be published in Volume 78 of the Stanford Law Review but is currently available on SSRN.
