Board Independence in Banks: Does it make any difference?

Professor Francesco Vallascas

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Francesco is a Professor of Banking at the Business School and holds a PhD in Finance from Leeds. He has previously worked as a Lecturer in Financial Intermediation at the University of Cagliari and with the research centre of the European Commission.

Since the global financial crisis banks have been encouraged to hire more independent directors. With increased objectivity and a fresh perspective, can these individuals affect change within the sector and safeguard the interests of bank creditors and taxpayers in the face of reckless risk-taking pre 2008?

In short the answer appears to be no. Research indicates that the presence of independent directors on bank boards has not curtailed risk-taking at the majority of the world’s largest banks since the global financial crisis.

Academics at Leeds University Business School and Hull University Business School looked at the number of independent directors on the boards of more than 260 of the world’s largest banks between 2004 and 2009 to determine whether institutions with more independent directors took a more prudent approach to business before and after the global economic downturn.

The research initially appeared to show that the presence of independent directors was linked to reduced risk-taking after the global crisis. However closer analysis showed that risk-taking following the crisis was reduced only at banks which received a public bail-out. For a greater number of banks, the presence of independent directors had no discernible effect on risk-taking.

A photograph of a bank entrance.

Although independent directors were seen as having an important role to play, by increasing the level of scrutiny in management decisions, do they do enough by way of safeguarding against another crisis?

Lead author Francesco Vallascas, Professor of Banking at Leeds University Business School, said: “Recent regulatory documents suggest that independent directors should represent stakeholders’ interests and, for a number of leading global banks, this includes taxpayers following the billion dollar public bail-outs that some received.

“Independent directors should ensure that banks act more carefully, and don’t engage in the so-called ‘casino-style’ activity which caused so many problems in the global crisis.”

The study measured risk by looking at the probability that a bank might default, the volatility of bank share prices and the likelihood that a bank might suffer a major loss.

 


Professor Vallascas said that the results raised questions about the value of independent directors: “Banks which received a public bail-out are under additional scrutiny and it is unsurprising that these institutions take a more risk-averse approach. But for the majority of banks, it is highly questionable whether the independent directors do act as a safeguard.

“This raises questions about the role of independent directors and whether they are meeting their responsibilities. Are they really holding management to account? Are they asking the difficult questions which need to be asked if they are trying to ensure financial stability?”

The paper, ‘Does the impact of board independence on large bank risks change after the global financial crisis?’ was written by Professor Francesco Vallascas and Professor Kevin Keasey, Leeds University Business School, and Professor Sabur Mollah, Hull University Business School. It is published by the Journal of Corporate Finance.

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