Subprime Crisis and Board (In-)Competence

In the paper, Subprime Crisis and Board (In-)Competence: Private vs. Public Banks in Germany, which was recently made publicly available on SSRN, we examine evidence for a systematic underperformance of Germany’s state-owned banks in the current financial crisis and study if the bank losses can be traced to the quality of bank governance.

For this purpose, we examine the biographical background of 593 supervisory board members in the 29 largest banks and find a pronounced difference in the finance and management experience of board representatives across private and state-owned banks. Measures of “boardroom competence” are then related directly to the magnitude of bank losses in the recent financial crisis. Our data confirms that supervisory board (in-)competence in finance is related to losses in the financial crisis.

Overall, our case study shows that state ownership comes at the costs of weaker monitoring of bank managers, possibly higher risk exposure and higher bank losses in a financial crisis. This finding is important given that state-ownership has even increased in the wake of the current crisis. The policy conclusions are straightforward. First, state ownership in the banking sector should be reduced as far as possible. Second, whenever state ownership is unavoidable, the financial competences of the supervisory boards have to be strengthened. Instead of installing politically connected board members, the state should delegate financial experts to the supervisory boards. Third, private institutions may similarly benefit from a more competent supervisory board. Enhanced shareholder rights and better shareholder representation can also pave the way for more bank board quality and more effective monitoring. Fourth, it seems worth exploring whether prudential bank regulations should explicitly encompass criteria for board competence and quality. These measures offer a promising path towards more financial stability because at the heart of any financial crisis are large bank losses.

The full paper is available for download here.