INSEAD Working Paper 2011/33/FIN
Following the publication of the Walker Report (2009) in the United Kingdom, international organizations such as the Basel Committee (2010), the OECD (2010), and the European Union (2010) have proposed guidelines to improve bank corporate governance and, more specifically, risk governance. These international reports vary widely on what the prime objective of bank corporate governance should be, with one group recommending a shareholder-based approach, and the other a stakeholder-based one. Moreover, the focus of these reports is exclusively on risk avoidance, with little guidance as to how an acceptable level of risk should be defined. Drawing on insights from economics and finance, this paper is designed to contribute to the debate on bank corporate governance. Our four main conclusions are as follows. Firstly, the debate on bank governance should concern not only the boards but also the governance of banking supervision with clearly identified accountability principles. Secondly, since biases for short-term profit maximization are numerous in banking, boards of banks should focus on long-term value creation. Thirdly, board members and banking supervisors should pay special attention to cognitive biases in risk identification and measurement. Fourthly, a value-based approach to risk taking must take into account the probability of stress scenarios and the associated costs of financial distress. Mitigation of these costs should be addressed explicitly in the design of bank strategy.