New York Fed Releases Report Providing an In-Depth Look at Behavioral Risk Management in the Financial Services Industry
August 22, 2016

NEW YORK—The Federal Reserve Bank of New York today released a special issue of its Economic Policy Review entitled “Behavioral Risk Management in the Financial Services Industry: The Role of Culture, Governance, and Financial Reporting.” The volume, which was four years in the making, includes nine research papers that aim to identify and understand the key factors affecting governance and culture in the banking industry.

“Corporate culture and governance have been central to every crisis involving U.S. business practices over the past century,” said Hamid Mehran, assistant vice president in the New York Fed’s Research and Statistics Group. “Today’s volume identifies and assesses key issues in banking culture and governance. By fostering a better understanding of the factors that drive financial stability, these insights can assist researchers and practitioners as they work to establish a stronger, healthier U.S. and international financial system.”

The volume is divided into two complementary parts. Part I introduces the concept of culture and its importance to risk management and financial stability. The articles present a framework for diagnosing and changing culture, describe how corporate culture is shaped, explore the importance of effective risk management, and examine the roles of deferred cash compensation and bank cash holdings in promoting financial stability. Part II assesses critical areas of corporate governance: the role of boards of directors, the monitoring function of large outside shareholders, the importance of financial disclosure and transparency, and the relationship between banks’ disclosure practices and performance.

Specifically, the papers in this volume:

  • examine the role of risk management in identifying and measuring “good” and “bad” risks, eliminating bad risks, and ensuring that a bank’s risk level is consistent with its risk appetite;
  • propose a new framework for diagnosing and changing corporate culture to more effectively support a bank’s growth strategy and encourage behavior that promotes financial stability;
  • explore the impact of culture in the financial industry and whether that culture can be changed;
  • propose a cash requirement for financial firms with the goal of inducing a conservative approach to risk taking and in turn limiting the expected social cost from the firms’ failure;
  • describe the ways in which a program of deferred cash compensation can mitigate potentially excessive risks taken by employees of financial firms with little regard for public interest and also promote internal monitoring and shared interest among employees;
  • examine the increasing complexity of bank activities as well as governance challenges posed by the holding company organization of banks, in which two boards of directors monitor the bank;
  • explore the consequences of accounting policy choices for individual banks’ downside tail risk, for the codependence of such risk among banks, and for regulatory forbearance, or the decision by a regulator not to intervene;
  • review the role of corporate financial reporting and transparency in reducing governance-related agency conflicts and suggest avenues for future research on the issue; and
  • assess the relationship between the amount of information disclosed by bank holding companies and the subsequent risk-adjusted performance of those companies.

The nine papers in the volume are:

Part I: Culture and Risk Management

  • “Corporate Culture in Banking” by Anjan Thakor
  • “The Gordon Gekko Effect: The Role of Culture in the Financial Industry” by Andrew W. Lo
  • “Risk Management, Governance, Culture, and Risk Taking in Banks” by René M. Stulz
  • “Deferred Cash Compensation: Enhancing Stability in the Financial Services Industry” by Hamid Mehran and Joseph Tracy
  • “Cash Holdings and Bank Compensation” by Viral Acharya, Hamid Mehran, and Rangarajan K. Sundaram

Part II: Governance and Financial Reporting

  • “Bank Corporate Governance: A Proposal for the Post-Crisis World” by Jonathan Macey and Maureen O’Hara
  • “The Role of Financial Reporting and Transparency in Corporate Governance” by Christopher S. Armstrong, Wayne R. Guay, Hamid Mehran, and Joseph P. Weber
  • “Transparency, Accounting Discretion, and Bank Stability” by Robert M. Bushman
  • “Public Disclosure and Risk-Adjusted Performance at Bank Holding Companies” by Beverly Hirtle

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