Banks take costly actions (such as capitalization, liquidity holding, and advanced risk management) to avoid financial distress and creditor runs. While directly affecting a bank’s risks, such actions can also signal the bank’s fundamentals. We show that prudential regulations have an informational impact: sufficiently tight regulations can eliminate inefficient separating equilibria in banks’ signaling game, thereby changing the information available to creditors and their incentives to run. When accounting for this informational impact, tightening regulations can improve banks’ payoffs and be considered bank incentive-compatible. We support this novel, information-based rationale for regulations with evidence from the US liquidity requirement.

We find that shareholder-friendly corporate governance is associated with higher stand-alone and systemic risk in the banking sector. Specifically, shareholder-friendly corporate governance results in higher risk for larger banks and for banks that are located in countries with generous financial safety nets as banks try to shift risk toward taxpayers. We confirm our findings by comparing banks to nonfinancial firms and examining changes in bank risk around an exogenous regulatory change in governance. Our results underline the importance of the financial safety net and too-big-to-fail guarantees in thinking about corporate governance reforms at banks.