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Bank Governance Structures and Risk Taking

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Dennis Froneberg

The book sheds light on two closely related and highly relevant governance themes: the composition of supervisory boards and financial expertise as well as ownership structure. The author focuses on the financial expertise of supervisory boards and its impact on performance and risk. He analyses how supervisory boards are composed and how much financial expertise their members have, assesses the impact of financial expertise on a banks’ risk-return profiles and investigates if financial expertise in internal bank governance contributes to more stability and less risk taking in banking. Finally, he examines the effects of the ownership structure on credit risk. He finds that banks with a more concentrated ownership structure tend to behave riskier, which is indicated by larger CDS spreads.
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IV Bank Governance Structures, Financial Expertise of Supervisory Board Members, Overconfidence, and Bank Risk Taking

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9

Abstract In this study, we analyze whether financial expertise in internal bank governance benefits the financial institution by reducing risk and increasing stability. Whereas behavioural finance theory scrutinizes the benefit of financial expertise, empirical studies substantiate that financial experts do add value. Based on a study of more than 400 German banks, we observe that the financial expertise of supervisory board members reduces stability and increases loan portfolio risk. This finding is robust across ownership types. With regard to performance, the results demonstrate that supervisory board competence impacts banking groups in different ways. In general, our results lead to the question how effective universal expertise in internal governance is; therefore, we propose that financial institutions should have experts for specific responsibilities and areas on their supervisory boards.

IV.1 Introduction

In 1999 and 2006, the Basel Committee on Banking Supervision had already emphasized the high relevance of board competence for an effective governance system (Basel Committee on Banking Supervision, 1999b, 2006a). As one of its principles for an effective governance system, the committee demands that “board members should be qualified for their positions, have a clear understanding of their role in corporate governance and be able to exercise sound judgment about the affairs of the bank” (Basel Committee on Banking Supervision, 2006a). The recent 2008 banking crisis sheds additional light on the significance of governance structure in general and board expertise in particular: inappropriate risk management, incomplete risk information, and insufficient industry expertise were...

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