A Credible Sanctions Regime for Negligent Bankers: The Key to Preventing Future Financial Crises

In a tumultuous week in 2023, the global financial system teetered on the brink, triggered by rapid depositor runs at several U.S. banks. The immediate aftermath saw the collapse of three of the largest banks in U.S. history: Silicon Valley Bank, Signature Bank, and First Republic Bank. Across the Atlantic, the venerable Credit Suisse, a pillar of European finance, became the most significant financial institution to fail since the catastrophic 2007-2008 global financial crisis. This alarming sequence of events ignited urgent calls from lawmakers, regulators, and academics for a fundamental overhaul of the U.S. financial regulatory framework, with leading proposals advocating for enhanced supervisory oversight, tighter existing regulations, and increased deposit insurance limits.

However, a new and provocative paper, "Sanctioning Negligent Bankers," authored by Will Thomas, Kyle Logue, and Jeffrey Zhang from the University of Michigan, challenges the sufficiency of these widely discussed reforms. The researchers contend that these proposals alone are inadequate to avert the next wave of bank collapses and, critically, might even exacerbate a core problem contributing to bank runs: the unchecked behavior of bankers themselves. Their groundbreaking work argues for pairing conventional regulatory improvements with a robust, credible sanctions regime specifically targeting negligent bankers, pushing accountability directly back into the C-suite.

The Genesis of a Crisis: A Detailed Chronology of the 2023 Bank Failures

The 2023 banking turmoil unfolded with startling speed, revealing vulnerabilities in a system largely assumed to be robust after the post-2008 reforms. The crisis began with Silicon Valley Bank (SVB), a financial institution deeply embedded in the technology and venture capital ecosystem. For years, SVB had benefited from a flood of deposits from booming tech startups and venture capital firms. These deposits, largely uninsured due to exceeding the $250,000 FDIC limit, grew rapidly, especially during the pandemic-era tech boom.

SVB, like many banks, invested these deposits in what were considered safe, long-term assets, primarily U.S. Treasury bonds and mortgage-backed securities. However, as the Federal Reserve aggressively raised interest rates in 2022 to combat inflation, the market value of these existing, lower-yielding bonds plummeted. Simultaneously, as the tech sector faced headwinds and startups burned through cash, SVB’s clients began withdrawing their deposits at an accelerated pace.

On March 8, 2023, SVB announced a significant loss from the sale of its securities portfolio and a plan to raise capital, triggering widespread panic among its highly interconnected client base. Social media amplified the fear, leading to an unprecedented digital bank run. Within hours, depositors attempted to withdraw billions, far exceeding the bank’s liquidity. By March 10, regulators stepped in, closing SVB and placing it under FDIC receivership. This marked the largest bank failure since Washington Mutual in 2008, with SVB holding approximately $209 billion in assets.

The contagion spread almost immediately. Signature Bank, a New York-based institution with a significant presence in the cryptocurrency industry, faced similar pressures. Its large, uninsured corporate deposits, coupled with its exposure to the volatile crypto market, made it vulnerable. Regulators closed Signature Bank on March 12, citing systemic risk, with assets totaling around $110 billion.

The tremors continued, leading to severe stress at First Republic Bank, a San Francisco-based lender catering to affluent clients. Despite a consortium of large banks injecting $30 billion in deposits to stabilize it, confidence eroded. Its balance sheet, laden with low-interest mortgages to wealthy clients and substantial unrealized losses on securities, proved unsustainable. After failing to find a private rescue, First Republic was seized by regulators on May 1, 2023, and subsequently sold to JPMorgan Chase in the second-largest bank failure in U.S. history, with assets of roughly $229 billion.

Globally, the crisis resonated most profoundly with Credit Suisse. Already reeling from years of scandals, governance issues, and dwindling investor confidence, the U.S. bank failures pushed the Swiss giant to the brink. Its stock plunged, and depositors began withdrawing funds en masse. Swiss authorities orchestrated an emergency, government-backed takeover by its rival, UBS, on March 19, a dramatic end for an institution founded in 1856. The merger created a banking behemoth, but also highlighted the fragility of even the largest global financial players.

The Traditional Response and the Problem of Moral Hazard

The initial and traditional governmental response to bank runs in the United States, as articulated by Will Thomas, has historically centered on the Federal Deposit Insurance Corporation (FDIC) insurance program. Established in 1933 in the wake of the Great Depression, the FDIC’s primary goal was to restore public confidence in the banking system by guaranteeing depositors’ funds up to a certain limit. This "carrot" of insurance ensures that most individual depositors feel secure, preventing widespread panic and systemic collapse. The current insurance limit stands at $250,000 per depositor, per insured bank, for each account ownership category.

"The traditional story of how the United States got a handle on bank runs is through FDIC insurance," Thomas explained in an interview with Corporate Crime Reporter. "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."

However, the 2023 crisis exposed a critical weakness in this system, particularly concerning large corporate and institutional depositors. "What we found in 2023 is that that old system, while it’s still in place, has a weakness to it," Thomas noted. "And one weakness is that the FDIC only insures up to a certain amount… Most businesses are way above that cap. And Silicon Valley Bank is an example of what happens when a lot of your depositors are in the second bucket." The vast majority of SVB’s deposits, for instance, were uninsured, triggering the rapid exodus when confidence wavered.

In response to this vulnerability, many proposed reforms advocate for increasing the FDIC insurance limit, potentially even to unlimited coverage for business accounts, or making explicit government guarantees. While such measures might address the immediate liquidity risk, they simultaneously amplify a long-standing economic concern: moral hazard.

Moral hazard, in the context of banking, refers to the increased willingness of individuals or institutions to take on greater risks when they are protected from the full consequences of those risks. If bank executives believe that depositors (and by extension, their banks) will be fully insured or bailed out by the government, the incentive to meticulously manage risk diminishes. "Exactly right," Thomas affirmed when asked about this phenomenon. "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 University of Michigan researchers argue that simply enhancing the "carrot" of insurance or institutional regulation without strengthening the "stick" of individual accountability will only exacerbate this moral hazard, leading to a banking sector more prone to excessive risk-taking and eventual collapse.

"Sanctioning Negligent Bankers": A Framework for Personal Accountability

The core of Thomas, Logue, and Zhang’s proposal lies in the creation of a credible sanctions regime for negligent bankers, designed to complement existing regulatory frameworks rather than replace them. They emphasize that while deposit insurance is vital and successful in preventing systemic runs among small depositors, it must be balanced with robust oversight and accountability. "We agree with the consensus here. Deposit insurance is great. It has been very successful at solving this very important systemic problem of bank runs in US history," Thomas said. "On the other hand, the reason that deposit insurance has been so successful, specifically in the United States, is that the United States has always taken a carrot and stick approach. The carrot is the insurance. And the stick is aggressive ex ante regulation."

The researchers identify a crucial gap: "Right now, there’s a lack of after the fact regulation of bankers. What we’re proposing is some kind of sanction regime for the bankers who really do screw up."

Their proposed liability regime centers on a civil penalty designed to disgorge compensation from bank executives whose negligence substantially increases the risk of a bank collapse. This is distinct from existing criminal statutes, which typically require a higher burden of proof and focus on outright fraud or embezzlement. The proposed sanction targets a broader range of behavior: gross negligence and undue risk-taking that falls short of criminal intent but still poses significant systemic risk.

Key Features of the Proposed Regime:

1. Civil Penalty, Not Criminal Punishment: The authors advocate for a civil penalty due to its lower evidentiary threshold compared to criminal charges, making it more feasible to pursue cases of negligence. While criminal laws exist for extreme cases of fraud, they are often difficult to prove and are rarely applied to the type of negligence that leads to systemic risk. A civil approach can more effectively deter risky behavior without the complexities of criminal prosecution.

2. Disgorgement of Compensation: The primary sanction would be a "clawback" of an executive’s compensation. If a bank collapses or is taken over by the federal government, and the government can demonstrate that a banker’s negligence substantially contributed to that collapse, the executive would be required to return a significant portion of their earnings. "The sanction is going to be calculated based on how much that banker made over the past five years," Thomas explained. "Think of it like a clawback. All the money that you made in your position is going to be clawed back by the government."

3. No Insurance Backstop: A critical element of the proposal is that executives should not be allowed to insure against this civil penalty. This prevents the cost of accountability from simply being passed on to insurance companies or shareholders, ensuring that the personal financial consequences remain directly with the negligent executive. This feature is designed to maximize the deterrent effect.

4. Automatic Trigger: The enforcement action would automatically kick in upon a bank collapse or federal takeover, reducing the discretion of regulators who, as Thomas points out, "are not really interested in bringing enforcement actions against individual bankers, they don’t see themselves as sort of cops on the street." This mechanism aims to ensure consistent application of the sanction.

The "Industrial Disaster" Analogy: A Model for Dual Deterrence

To buttress their argument, the University of Michigan team draws a compelling analogy between bank collapses and industrial disasters. They delve into the law and economics literature on optimal enforcement practices, which examines how to prevent events with catastrophic ripple effects, such as plane crashes, environmental explosions, or large-scale industrial accidents.

"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," Thomas clarified.

The literature on industrial disasters suggests a "hybrid model of sanction" for effective deterrence:

1. Corporate Penalty: There must be an incentive for the firm itself (the bank) to police its own behavior, often through fines or other institutional penalties. The banking sector already has these, such as fines, capital requirements, and regulatory interventions.
2. Individual Sanction: This alone is not enough. There must also be a separate risk or sanction for the individuals within the firm who make critical decisions. Firms can only police their employees up to a point; personal accountability creates a stronger incentive for individual diligence.

"We think that same model actually makes a lot of sense in the banking context," Thomas stated. "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." This dual approach ensures that both the institution and its key decision-makers are incentivized to manage risk prudently.

Current Regulatory Gaps and the Path Forward

While existing regulations do impose "rules of the road" for banks, their focus is predominantly on the institution as a whole, rather than on individual executives for negligence. "Most of the regulatory body is geared toward the institution, toward the bank writ large, as opposed to individual bankers," Thomas observed. While some rules apply to individuals, and criminal laws address fraud, there’s a significant gap in holding bankers personally accountable for gross negligence that doesn’t meet the high bar of criminal intent.

Moreover, regulators have historically shown reluctance to pursue individual enforcement actions, often preferring to work with institutions. The proposed automatic trigger and mandatory clawback mechanism aim to reduce this discretion, ensuring that accountability is consistently applied when negligence contributes to a bank’s failure.

Implications for Financial Stability and Policy Makers

The implications of this proposal are profound. By shifting a tangible portion of the liability onto the individual decision-makers in the C-suite, the framework aims to realign incentives within the banking sector. Executives, knowing that their personal compensation is at stake, would be compelled to exercise greater diligence, improve risk management practices, and resist the temptation for excessive risk-taking driven by short-term profit motives.

This shift in responsibility could lead to the enhanced financial stability desperately sought by policymakers in the wake of the 2023 crisis. It represents a move beyond merely shoring up institutional safeguards and addresses the human element at the heart of financial decision-making.

"It is time to bring personal accountability back into the picture by pairing regulatory improvements with a credible sanction regime for bank executives," the authors conclude in their paper. "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."

As Congress and regulators deliberate the future of financial oversight, the University of Michigan’s proposal offers a compelling, yet challenging, new direction. It moves beyond incremental adjustments to existing rules, instead advocating for a fundamental recalibration of accountability that could fundamentally alter the risk calculus for those at the helm of the world’s most critical financial institutions. The question remains whether policymakers are prepared to implement such a robust "stick" to complement the existing "carrot" in the ongoing quest for a resilient and stable banking system.