The application of the German model of company law to the banking sector: A private law measure to avert systemic risk

Abstract

Since bank failures and its systemic and contagion effects have become an issue, various ex-ante and ex-post solutions have been contemplated and put forward to tackle the bank failure or and to manage its consequences. Among the ex-ante measures to tackle and avert the excessive risk-taking by banks, regulatory intervention through mandatory capital adequacy as exemplified in the Basel Accords, has been popular. However, even the most recent arrangements for implementing the capital adequacy standards have not been very successful leading to regulatory failures. Bank failures not only inflict costs and losses to the shareholders and depositors of the bank, the managers of which take excessive risk, but also the contagion effects mean the losses are extended to the banking system and the society at large. In this paper, we are proposing an ex-ante private law mechanism through the reform of company law rules to stop excessive risk-taking by the bank managers, and therefore avoiding the systemic risk which has far more ramifications for society as a whole. The solution we are proposing is rather a corporate governance scheme under which a two-tier management regime consisting of a supervisory board and management board. As it has been the feature of German company law, the supervisory board allows stakeholders of the bank including depositors and central banks, employees and creditors, to participate in the management of the company and control the executive members of the board in terms of the level of risk-taking. This ex-ante mechanism as a private law measure is theoretically more effective and less costly compared to regulatory schemes.