Neither regulation nor market forces have fixed problem with financial institution corporate governance and incentives

In a Vox column, three economists look at why neither regulation nor market forces have fixed the problem with financial institution corporate governance and incentives.

What they found was opacity blocked the ability of either regulation or market forces to fix the problem.

This column is another source of confirmation for why banks need to be required to provide ultra transparency and disclose on an ongoing basis their current asset, liability and off-balance sheet exposure details.

A recent op-ed by former Goldman Sachs employee Greg Smith has led to an outcry over Goldman Sachs’ perceived mistreatment of their customers. This illustrates two important themes in the financial sector, both of which came to the fore during the crisis, ie corporate culture and incentives. 

Obviously, neither regulation nor market forces has put either of these issues to rest.... 

The boards of financial institutions must give clear leadership on culture and incentives..... 

Many commentators have suggested that inexperienced independent directors are unable to fulfil their governance role. But, as we point out in Mehran et al (2012), experience is no panacea. For example, Northern Rock’s board included a former bank CEO, a top fund manager, and a previous member of the Bank of England’s governing body, while Bear Stearns had a board on which seven of 13 members had a banking background. 

Recent calls for more banking expertise in the boardroom reflect the incredible, and growing, complexity of modern financial firms. Modern techniques have been developed for coping with this complexity, using Value at Risk systems and credit ratings. 

These techniques, however, have proved ineffective, in part because increases in bank complexity have been accompanied by increased bank opacity....

The complexity of modern banks partly reflects their increasing size and scope. These increases have produced a situation where the social costs of a failure of these institutions are greatly magnified, creating the too-big-to-fail problem. 

Bank complexity and the too-big-to-fail policy both serve to undermine market discipline. 

regulators and investors are less able to understand banks, and, hence, are less able effectively to discipline them.

The fact that 'regulators and investors are less able to understand banks, and, hence, are less able effectively to discipline them' is the reason banks must be required to provide ultra transparency.

It is only when this data is made available to all market participants that the market is able to assess the risk of these banks and to enforce market discipline.