University of Michigan Scholars Propose Sanctions for Negligent Bankers to Prevent Future Crises

A new paper from University of Michigan scholars Will Thomas, Kyle Logue, and Jeffrey Zhang argues that current proposals to reform the U.S. financial system are insufficient to prevent future bank collapses. Following a week in 2023 that saw three of the largest U.S. bank failures and the collapse of Credit Suisse in Europe, lawmakers and academics have called for increased supervisory oversight, tighter regulations, and higher deposit insurance limits. However, Thomas and his colleagues contend that these measures alone may exacerbate a critical issue: the negligence of bankers themselves.

The paper, titled "Sanctioning Negligent Bankers," advocates for pairing regulatory improvements with a credible sanctions regime targeting negligent bank executives. The authors propose a civil penalty designed to claw back compensation from C-suite leaders whose negligence substantially contributes to the risk of a bank failure. This approach aims to reintroduce personal accountability, shifting liability onto those best positioned to prevent collapses, and addressing the moral hazard created by deposit insurance, which can encourage excessive risk-taking by executives.

The scholars emphasize that while deposit insurance is vital for maintaining depositor confidence and preventing systemic runs, it also incentivizes bankers to take greater risks knowing the government will backstop failures. Their framework seeks to balance the benefits of insurance with a mechanism that holds executives responsible for their decisions, particularly concerning uninsured deposits, which proved problematic in the 2023 failures. By implementing a system that directly impacts negligent bankers, the proposal aims to foster greater financial stability and reduce the likelihood of future crises.