By Ryan Hahn
That is the one of the main contentions of a new Crisis Response Policy Brief from the World Bank on Bank Governance. Jumping right to the conclusion:
While studies and reviews document several governance failures, one common conclusion is that much of the existing governance framework is generally adequate and should remain intact. But the devil is in the details of implementation. A key priority is to increase the capacity of boards to oversee strategic risk taking and to accurately judge institutional performance.
But how is it that we could have the principles right and the implementation wrong? Shouldn't good principles by definition lend themselves to effective implementation? I would posit that principles matter little if they are not animated by a set of beliefs that those principles serve some important function.
I am in the middle of reading a magisterial work on financial crises entitled This Time is Different: Eight Centuries of Financial Folly. Authors Carmen Reinhart and Kenneth Rogoff hypothesize a relatively straightfoward cause for the crisis (if I may simply quite a bit): hubris. As earlier crises fade from living memory, the financial industry convinces itself that it has improved its ability to manage risk sufficiently to make it immune to crises. It is hard to see how any governance principles, no matter how well thought out, could prevent excessive risk taking by financial institutions if noone believes that crisis could strike.
If we buy the hypothesis that Reinhart and Rogoff are selling, then the belief that banks have the principles of governance all figured out was in some ways a liability, since it fed into the hubris that "this time is different." This probably goes a long way toward explaining what the authors of the Crisis Reponse Policy Brief describe as one of the central ironies of the crisis:
The central irony of the governance failures in this crisis is that many took place in some of the most sophisticated banks operating in some of the most developed governance environments in the world.