Reimagining Financial Accountability: A Call for Sanctions on Negligent Bankers

In a tumultuous week in March 2023, the global financial system teetered on the brink as depositor runs at several U.S. banks ignited fears of a widespread crisis. The rapid succession of failures, including Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank, marked three of the largest bank collapses in American history. Across the Atlantic, the venerable Swiss institution Credit Suisse faced its own existential crisis, ultimately becoming the largest financial entity to fail since the cataclysmic global financial crisis of 2007-2008. These events sent shockwaves through markets, prompting an urgent re-evaluation of the existing financial regulatory framework.

In the aftermath, a chorus of voices from lawmakers, regulators, and academics emerged, advocating for substantial reforms. Dominant among these proposals were calls for enhanced supervisory oversight of banks, a tightening of existing financial regulations, and an increase in deposit insurance limits. While these measures address critical systemic vulnerabilities, a new paper from the University of Michigan – authored by Will Thomas, Kyle Logue, and Jeffrey Zhang – argues that such proposals, while necessary, are fundamentally insufficient to prevent future waves of bank collapses. More strikingly, the researchers suggest these widely discussed reforms could inadvertently exacerbate a core problem contributing to bank runs: the inherent incentives and potential negligence of the bankers themselves.

The Anatomy of a Crisis: March 2023’s Financial Tremors

The events of March 2023 unfolded with alarming speed, demonstrating the fragility of confidence in the modern banking system, particularly in the digital age. The crisis began with Silicon Valley Bank, a lender deeply embedded in the technology and venture capital sectors. For years, SVB had experienced explosive growth, fueled by a surge in tech startup funding. Its deposit base swelled, and much of this liquidity was invested in long-dated, low-yield government bonds. This strategy proved disastrous when the Federal Reserve aggressively raised interest rates in 2022 and early 2023 to combat inflation. As interest rates climbed, the market value of SVB’s bond portfolio plummeted.

Compounding this problem was SVB’s highly concentrated depositor base, largely composed of tech companies and wealthy individuals whose deposits often far exceeded the standard $250,000 FDIC insurance limit. When news of SVB’s unrealized losses and its attempt to raise capital broke on March 8, 2023, fear quickly spread through its interconnected client network, amplified by social media. Depositors initiated a digital bank run, attempting to withdraw billions in a matter of hours. On March 10, regulators stepped in, closing SVB to prevent its collapse from spiraling further. The speed of the run was unprecedented, highlighting how modern technology could accelerate traditional banking crises.

The contagion was immediate. Just two days later, on March 12, New York-based Signature Bank, another significant lender to the cryptocurrency industry and other businesses with large uninsured deposits, was also closed by regulators, citing similar systemic risk concerns. The closures underscored a critical vulnerability: while FDIC insurance protected small depositors, large, uninsured deposits were highly susceptible to panic-driven withdrawals.

The fear then spread to First Republic Bank, a San Francisco-based lender with a high proportion of wealthy clients and large uninsured deposits. Despite an unprecedented $30 billion rescue package from a consortium of major banks, confidence eroded, and its stock price plunged. On May 1, 2023, First Republic was seized by regulators and subsequently sold to JPMorgan Chase, marking the third major U.S. bank failure in less than two months. The collective assets of these three banks amounted to hundreds of billions of dollars, making their failures historically significant.

Concurrently, Europe faced its own financial reckoning with Credit Suisse. Plagued by years of scandals, management missteps, and significant losses, the bank’s stock price plummeted in mid-March, triggering a crisis of confidence among investors and depositors. Swiss authorities orchestrated a forced takeover by rival UBS on March 19, 2023, to prevent a broader European financial meltdown. The Credit Suisse saga, while distinct in its proximate causes, contributed to the overall atmosphere of global financial instability.

The Traditional Response and Its Limitations: Moral Hazard

The standard approach to mitigating bank runs in the U.S. has long centered on deposit insurance, primarily through the Federal Deposit Insurance Corporation (FDIC). As Will Thomas elaborated in an interview, "The traditional story of how the United States got a handle on bank runs is through FDIC insurance. In essence, what the government has said is we want to make depositors feel comfortable participating in the national banking system. The way we’re going to do that is we are going to heavily regulate banks and financial institutions on the front end and then and on the back end, we’re going to say — if something happens, if this entity fails, don’t worry, depositors, we have your back. The government will, in essence, bail you out."

This system, established in the wake of the Great Depression, has been remarkably successful in preventing widespread panics among small depositors. However, the 2023 crisis exposed a critical weakness: the $250,000 per depositor insurance limit. While sufficient for most individual accounts, it proved inadequate for businesses and high-net-worth individuals with much larger balances. SVB, for instance, had an estimated 90% of its deposits uninsured, creating a potent catalyst for a swift, catastrophic run when confidence wavered.

In response, many policymakers advocated for increasing the FDIC insurance limit, potentially even to unlimited coverage for business accounts. While this might address the "acute problem" of uninsured deposits, Thomas and his colleagues caution against such a singular focus due to the principle of "moral hazard."

Moral hazard, in this context, refers to the increased willingness of financial institutions and their executives to take on greater risks because they perceive a reduced downside. If the government implicitly or explicitly guarantees deposits, regardless of size, bankers may feel less compelled to meticulously manage risk. "The moment you provide insurance, you create moral hazard, you create new risks," Thomas explained. "And our particular worry is, there’s already a risk about bankers not monitoring, being negligent. The kinds of reforms that everybody is clamoring for right now are only going to exacerbate that problem."

He articulated this dilemma starkly: "As a banker, you have two jobs. Don’t lose your depositors’ money and make a profit for the bank. You gotta balance those two jobs. Well, the government is taking that first job off the table — they are telling the bankers — don’t worry you, you can’t lose depositors money. Well, that just means you’re going to tilt hard towards — let’s do something risky and make as much money as possible. So the insurance is encouraging more risk from the leaders of the banks than we probably want to see out there."

The authors are not arguing for the abolition of deposit insurance, acknowledging its historical success in stabilizing the U.S. banking system. Instead, they emphasize that deposit insurance has been effective precisely because it was part of a "carrot and stick" approach, where the "stick" was aggressive ex ante (before the fact) regulation. What they identify as missing, however, is a robust "after the fact" accountability mechanism for individual bankers.

A New Paradigm: Sanctioning Negligent Bankers

This perceived gap in accountability forms the bedrock of the University of Michigan team’s proposal, outlined in their paper, "Sanctioning Negligent Bankers." The authors – Will Thomas, an expert in white-collar crime; Kyle Logue, an insurance expert; and Jeffrey Zhang, a banking expert – collaboratively developed a framework designed to reintroduce personal responsibility into the C-suite.

Their core argument is that proposals focused solely on institutional oversight or increased deposit insurance, while valuable, do not address the fundamental human element of risk-taking and negligence at the highest levels of financial institutions. They advocate for pairing regulatory improvements with a credible sanctions regime directly targeting negligent bankers.

Specifically, they propose a civil penalty designed to "disgorge compensation" from a bank executive whose negligence substantially contributes to the risk or actualization of a bank collapse. This is not about creating new criminal offenses, which are reserved for extreme cases of fraud or embezzlement. Instead, it aims to capture a broader range of behavior that falls short of criminal activity but still involves "grossly negligent" risk-taking.

The proposed mechanism is structured as a clawback provision. In the event of a bank collapse, or even a federal government takeover to prevent a collapse, this enforcement action would automatically trigger. If regulators can demonstrate that a banker’s negligence significantly contributed to the institution’s demise, that individual would be required to return a portion of their compensation earned over the preceding five years. The critical distinction of this proposal is that this clawback would operate "without an insurance backstop," meaning executives could not shield themselves from this personal liability through D&O (Directors and Officers) insurance policies. This feature is intended to ensure that the personal financial risk is real and direct.

Banking Failures as Industrial Disasters: A Framework for Accountability

To underpin their proposal, the researchers draw a compelling analogy between bank collapses and industrial disasters, leveraging insights from law and economics literature on optimal enforcement practices. Thomas elaborated on this perspective: "This paper is not motivated by the idea that we need to go after the bankers because they’re evil or something like that. We just want to get a well balanced deterrence regime in place so that we get a vibrant banking economy without extra risk."

The literature on preventing catastrophic industrial events – such as plane crashes, environmental explosions, or major chemical spills – suggests that an optimal enforcement regime requires a dual approach. First, there must be incentives for the firm itself, typically in the form of corporate penalties, to encourage internal policing and risk management. Second, and equally crucial, there must be separate sanctions or risks for the individuals within the firm who make critical decisions. A firm can only police its employees to a certain extent; individual accountability creates an additional layer of deterrence that corporate-level sanctions alone cannot achieve.

"We think that same model actually makes a lot of sense in the banking context," Thomas asserted. "These explosions in the financial sector have massive ripple effects. So how do you get a single bank to internalize the risk of causing that kind of harm? You need to both have sanctions against the bank, which we already have, but what we’re adding is a real sanction regime against the bankers."

Current regulations, while extensive, predominantly target the institution as a whole. While some rules apply to individual bankers, and criminal laws exist for egregious offenses, regulators have historically shown a reluctance to pursue individual enforcement actions, viewing their role more as front-end supervisors than "cops on the street." The proposed regime aims to reduce this discretionary element, making the consequence for negligence more automatic and predictable.

Implications and the Path Forward

The implementation of such a "negligent banker sanction" regime carries profound implications for the financial industry. By shifting the prospect of personal liability onto the C-suite, it would fundamentally alter the risk-reward calculus for bank executives. No longer would the potential for government bailouts or institutional fines fully insulate individual decision-makers from the consequences of their actions.

The authors conclude with a powerful statement: "It is time to bring personal accountability back into the picture by pairing regulatory improvements with a credible sanction regime for bank executives. We have described here a framework in which a well-designed negligent banker sanction — one without an insurance backstop — can bring reassurance by shifting the prospect of liability onto the group best situated to prevent it: bank executives. Implementing this framework of shifting more responsibility back onto the decisionmakers in the C-suite could lead to the financial stability desperately sought by policymakers."

This proposal directly addresses the moral hazard created by systemic protections, providing a crucial "stick" to complement the "carrot" of deposit insurance. It seeks to instill a culture of heightened vigilance and responsibility, where the personal financial well-being of executives is directly tied to the prudent management of their institutions.

However, the path to implementation would involve significant considerations for Congress and regulators. Key features would need careful delineation: what constitutes "negligence" in a complex financial environment? How would the "substantial contribution" to a collapse be definitively proven? What would be the precise methodology for calculating the disgorged compensation? These questions would require robust legal and economic analysis to create a fair, effective, and enforceable framework.

Ultimately, the University of Michigan paper presents a compelling argument that true financial stability requires more than just institutional safeguards. It demands a recalibration of incentives at the individual level, ensuring that those entrusted with managing vast sums of public and corporate wealth bear a tangible, personal stake in preventing the next financial catastrophe. As the world continues to grapple with the aftershocks of the 2023 crisis, the call for personal accountability for negligent bankers offers a powerful, potentially transformative, direction for financial reform.