Annual Review 

Shareholder Enforced Market Discipline: How Much is Too Much?

16 Ann. Rev. Banking L. 311 (1997)

 

 

 

 

 

ABSTRACT

 In response to the widespread bank failures of the 1980s and early 1990s, the federal banking regulators developed an arsenal of regulatory weapons designed to impose the cost of bank failure on bank holding companies. Although many justifications for this regulatory strategy have been offered, it appears motivated at least in part by the hope that the threat of potentially massive liability will prompt bank holding companies to more actively monitor bank managers, thereby reducing risky bank activities and saving losses to the deposit insurance fund. While this regulatory dynamic holds much intuitive appeal, it is misguided. It is another example of regulators "fighting the last war."

Although excessively risky bank activity may have been a significant cause of the banking crisis recently past, and although the regulatory weapons may have the effect of discouraging banks from taking risks, the current regulatory arsenal amounts to overkill in light of other changes in the law. Specifically, the development of risk-based capital requirements has already effectively eradicated the risky activity problem that the holding company liability provisions are designed to reach. In the end, the excessive potential liability for bank holding companies creates excessive caution on the part of bank managers and puts the banking industry at a disadvantage relative to its competitors in the financial services industry. The consequences of over regulation can be devastating, especially when the excessive regulations themselves are unlikely to achieve their purported goal.

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