“The fundamental problem is the potential conflict that inherently arises from the interplay between economic incentives and excessive risk-taking”, said Erik Thedéen in a speech on Thursday at the School of Business, Economics and Law at the University of Gothenburg. Erik Thedéen analysed the causes underlying this problem and presented some of the measures introduced to mitigate it.
Problems associated with excessive risk-taking
Erik Thedéen identified two problems associated with excessive risk-taking: the risk arising for creditors and customers due to the failure of an individual bank and the risk arising for financial stability, which could have a negative impact on taxpayers due to the "too big to fail" problem.
Erik Thedéen took the position that excessive risk-taking is caused by factors such as (i) shareholder value, (ii) the agency problem that exists between employers and employees as well as between banks and society, (iii) the conflict between short-term and long-term and (iv) risk culture.
Erik Thedéen referred to the measures authorities have taken to mitigate the problems related to the incentive vs. risk-taking conflict. He highlighted several important measures that were introduced via the Basel III regulation in 2014, such as (i) a clearer organisational structure for risk and internal governance, (ii) clearer responsibilities of the board, and (iii) a stricter remuneration structure. He concluded that the objective of all of these measures was to change the banks' behaviour and risk culture, and that these changes to a large extent have been welcomed by the banking industry because they create a level playing field.
Erik Thedéen also mentioned the implementation of the Bank Recovery and Resolution Directive (BRRD) as another example of a specific measure that will strengthen the incentives of the banks' creditors to be more vigilant about the risks the banks are taking. "This in turn means that future bank failures will have less of an impact on taxpayers", concluded Erik Thedéen.