We study regulatory enforcement actions issued against US banks to show that both board monitoring and advising are effective in preventing misconduct by banks. While better monitoring by boards prevents all categories of misconduct, better advising prevents misconduct of a technical nature. Board monitoring increases the likelihood that misconduct is detected, increases the penalties imposed on the CEO, and alleviates shareholder wealth losses following the detection of misconduct by regulators. Our article offers novel insights on how to structure bank boards to prevent bank misconduct

We introduce a high quality proxy for bank misconduct that is constructed from Consumer Financial Protection Bureau (CFPB) complaint data. We employ this proxy to measure the impact of bank misconduct on the expansion of online lending in the United States. Using nearly complete loan and application data from the online lending market, we demonstrate that bank misconduct is associated with a statistically and economically significant increase in online lending demand at the state and county levels. This result is robust to the inclusion of bank credit supply shocks and holds for both broader and more narrowly-defined bank misconduct measures. Furthermore, we show that this effect is strongest for lower rated borrowers and weakest in states with high levels of generalized trust

Over the past 15 years, banks around the world have been confronted with substantial costs related to misconduct. In this paper, we examine the impact of provisions for misconduct costs on the behavior of UK banks. We first document that misconduct provisions have a significant and negative effect on capital ratios. Next, we show that banks whose capital is reduced by misconduct provisions decrease non-lending activities but increase lending. Lending growth is driven by profitable higher loan-to-value mortgages, which typically incur a lower capital risk-weighting compared to non-lending activities. These results suggest that when faced with a capital shock due to misconduct provisions, banks restore their capital ratios by shifting their balance sheet towards activities that optimize the ratio of profitability to risk-weighted assets

We test for a link between bank risk-taking and regulatory enforcements against US banks for financial misconduct. Misconduct-related enforcements are associated with increased bank risk-taking on several measures of risk, and there is some evidence that the impact of enforcements on risk-taking is accentuated in the presence of powerful CEOs and a higher proportion of institutional investor ownership and mitigated when executive boards are larger, older, more independent, more gender diverse, busier, and where independent directors are relatively inexperienced. The results are robust to alternative measures of bank risk-taking, and alternative estimation techniques, including controlling for endogeneity bias

Little is known about fraud in the financial services sector. Using a rich supervisory data set, this study dissects fraud at large U.S. banking organizations. We find that the impact of fraud extends beyond direct monetary costs. Severe tail fraud events lead banks to significantly reduce loan growth, with effects more pronounced at institutions with weaker capital and liquidity positions. We further document that tail fraud shocks are associated with tighter loan contract terms, even after controlling for borrower risk. These credit supply effects ultimately transmit to the real economy through reduced corporate investment among affected banks’ borrowers. Our analysis provides new detailed evidence on fraud in the U.S. financial services industry and its costs and consequences

Using a proprietary, hand-collected database of 251 sanctions issued by national and international authorities on 109 European banks, we investigate the deterrent effect of governance effectiveness at the country level on detected bank misconduct from 2009 to 2019. We also examine the impact of detected bank misconduct on depositor behavior to investigate how customer reaction is shaped by media coverage. Our empirical strategy based on probit and panel fixed effects shows the existence of a deterrent effect exerted by country governance effectiveness. Moreover, the instrumental regressions show that depositors react to detected bank misconduct by withdrawing their funds and that this reaction is stronger when news coverage is high

This study examines the spillover effect of bank financial misconduct on the uninsured deposits of peer banks within local markets. We first validate that misconduct banks experience an increase in deposit spreads and a corresponding outflow of deposits following the misconduct. We then show local peer banks exhibit divergent deposit responses, contingent on how misconduct is perceived by information recipients in different economic contexts. During normal periods, depositors receiving a negative signal about bank misconduct reallocate their funds from misconduct banks to local peers, a local reallocation effect that decreases deposit spreads and increases deposit inflows for peer banks. Cross‐sectional analysis further reveals that this local reallocation effect is more pronounced for financially sophisticated depositors, amplified when peer banks have strong fundamentals, but attenuated when misconduct banks are financially sound. During financial crisis periods, however, bank misconduct leads to withdrawals from both misconduct banks and their peer banks, a local contagion effect whereby local peer banks face increased deposit spreads and deposit outflows following the misconduct

This paper investigates whether gender-diverse bank boards can play a role in preventing costly misconduct episodes. We exploit the fines received by European banks from US regulators to reduce endogeneity issues related to supervisory and governance mechanisms. We show that greater female representation significantly reduces the frequency of misconduct fines, equivalent to savings of $7.48 million per year. Female directors are more influential when they reach a critical mass and are supported by women in leadership roles. The mechanism through which gender diversity affects board effectiveness in preventing misconduct stems from the ethicality and risk aversion of the female directors, rather than their contribution to diversity. The findings are robust to alternative model specifications, proxies for gender diversity, reverse causality, country and bank controls, and sub-sample analyses

Reviews the book "Bank Frauds: Their Detection and Prevention," 2nd ed., by Lester A. Pratt

This paper investigates whether social capital plays a role in bank misconduct. I find that U.S. banks headquartered in high social capital areas, as indicated by the strength of civic norms and the density of social networks, are less likely to face enforcement actions. This relationship is mainly significant for banks with a lower geographical dispersion, and it holds in a range of robustness and endogeneity tests. I run additional tests based on classes of enforcement actions, components of social capital, risk-taking, opacity, and bank actions associated with negative externalities. These tests deliver results supporting the idea that the main findings of the paper are largely attributed to social capital's role in exerting external discipline, which prevents misconduct-related behaviors in banks