Reimagining Financial Accountability: A Call for Sanctions Against Negligent Bankers

Over just one week in 2023, depositor runs at a few U.S. banks threatened a worldwide banking crisis, culminating in three of the biggest bank failures in the nation’s history. This domestic turmoil was mirrored in Europe, where Credit Suisse became the largest financial institution to fail since the tumultuous 2007-2008 global financial crisis. In the aftermath, a chorus of lawmakers, regulators, and academics has called for significant reforms to the U.S. financial regulatory framework. While many proposals focus on improving supervisory oversight, tightening existing regulations, and increasing deposit insurance limits, a new paper from University of Michigan scholars Will Thomas, Kyle Logue, and Jeffrey Zhang argues these measures alone are insufficient. Their research, titled Sanctioning Negligent Bankers, contends that such proposals might even exacerbate a central problem contributing to bank runs: the bankers themselves, necessitating a credible sanctions regime imposed directly upon negligent executives.

The Swift Unraveling: A Look Back at the 2023 Banking Crisis

The year 2023 brought an unexpected jolt to the global financial system, characterized by the rapid collapse of several prominent banks. The crisis began with the swift demise of Silicon Valley Bank (SVB) on March 10, 2023. As the 16th largest bank in the U.S. with over $200 billion in assets, SVB specialized in serving technology startups and venture capital firms. Its downfall was triggered by a classic bank run, fueled by concerns over its investment portfolio, which held significant unrealized losses due to rising interest rates, and a concentrated depositor base largely exceeding the FDIC’s $250,000 insurance limit. When the bank announced plans to raise capital and sell off assets at a loss, panic ensued among its tech-savvy customers, who rapidly withdrew billions of dollars through digital channels. In a mere 36 hours, over $42 billion was withdrawn, leading to the bank’s insolvency and subsequent takeover by the FDIC.

The contagion quickly spread. Just two days later, on March 12, New York-based Signature Bank, a major player in the cryptocurrency sector with over $110 billion in assets, also collapsed. Similar to SVB, Signature Bank experienced a massive outflow of uninsured deposits, exacerbated by concerns specific to the volatile crypto market. The rapid succession of these failures sent shockwaves through financial markets, prompting fears of systemic risk. Regulators, including the Treasury Department, Federal Reserve, and FDIC, took extraordinary steps, invoking the "systemic risk exception" to fully guarantee all deposits at both SVB and Signature Bank, including those above the FDIC’s standard limit, to stem broader panic.

Despite these interventions, the crisis was not over. First Republic Bank, another regional lender with a focus on high-net-worth clients, faced immense pressure. Despite a $30 billion lifeline from a consortium of major banks and assurances from regulators, its stock plummeted as depositors continued to withdraw funds. By May 1, 2023, First Republic was seized by regulators and sold to JPMorgan Chase, marking the third significant U.S. bank failure in less than two months and the second-largest bank failure in U.S. history after Washington Mutual in 2008.

Across the Atlantic, Europe grappled with its own major banking crisis. Credit Suisse, a venerable Swiss institution with a history spanning over 160 years, had been facing years of scandals and financial difficulties. The U.S. bank failures intensified concerns about its stability, leading to a significant loss of depositor and investor confidence. On March 19, 2023, Swiss authorities brokered an emergency takeover of Credit Suisse by its rival, UBS, for approximately $3.25 billion, a deal backed by massive government guarantees and liquidity support. This dramatic intervention underscored the global interconnectedness of financial markets and the fragility that can emerge when confidence erodes.

A Legacy of Crises: Historical Context of Banking Failures and Regulation

The 2023 events were not isolated incidents but rather the latest chapter in a long history of banking crises that have shaped modern financial regulation. Prior to the Great Depression, bank runs were a recurrent feature of the U.S. financial landscape, often leading to widespread economic disruption. The crisis of 1907, for instance, saw J.P. Morgan himself orchestrate a private bailout to prevent a complete collapse of the banking system.

The devastating impact of the Great Depression, which saw thousands of bank failures, spurred a fundamental rethinking of financial stability. This led to the creation of the Federal Deposit Insurance Corporation (FDIC) in 1933, a landmark reform designed to restore public confidence in the banking system. By insuring depositors’ money up to a certain limit, the FDIC effectively broke the cycle of panic-driven bank runs, transforming banking into a far more stable industry. This "carrot" of deposit insurance was paired with the "stick" of aggressive ex ante regulation, meaning strict rules and oversight applied to banks before problems arose.

However, the regulatory landscape has continually evolved in response to new challenges. The Savings and Loan (S&L) crisis of the 1980s, driven by deregulation and risky investments, cost taxpayers hundreds of billions of dollars. This was followed by the dot-com bubble burst and, most significantly, the 2007-2008 global financial crisis. The latter, triggered by the subprime mortgage market collapse and widespread securitization of risky assets, revealed deep flaws in financial oversight and led to the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. Dodd-Frank aimed to prevent future crises by increasing capital requirements, regulating derivatives, establishing new oversight bodies, and introducing "living wills" for large banks to facilitate orderly wind-downs.

Despite these layers of regulation, the 2023 crisis demonstrated that vulnerabilities persist, particularly among mid-sized banks that, in some cases, had been exempted from certain Dodd-Frank provisions through subsequent legislative amendments.

The Current Regulatory Landscape and its Limitations

The prevailing U.S. financial regulatory framework is a complex tapestry woven by multiple agencies—the Federal Reserve, FDIC, Office of the Comptroller of the Currency (OCC), and others—each with specific purviews. Its primary focus remains on regulating the institutions themselves, ensuring they maintain adequate capital, manage risk prudently, and adhere to operational standards. Banks are subject to regular examinations, stress tests, and capital requirements designed to absorb losses and prevent insolvency.

As Will Thomas explained in an interview with Corporate Crime Reporter, the traditional "carrot and stick" approach relies on deposit insurance to reassure depositors and aggressive upfront regulation to guide bank behavior. "The traditional story of how the United States got a handle on bank runs is through FDIC insurance," Thomas stated. "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: the FDIC only insures deposits up to $250,000 per depositor. While this covers the vast majority of individual accounts, it leaves large corporate and institutional deposits—which were prevalent at banks like SVB—exposed. When these uninsured depositors perceive risk, they have a powerful incentive to withdraw funds en masse, triggering a run. The crisis thus reignited calls to increase deposit insurance limits or to extend guarantees to all deposits, a move quickly adopted by regulators in the immediate aftermath of SVB and Signature Bank’s failures.

While such measures might address the immediate problem of depositor panic, the University of Michigan researchers argue that they overlook a crucial element: individual accountability. Thomas noted, "what we started to worry about is — the moment you provide insurance, you create moral hazard, you create new risks. 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."

Currently, regulatory actions against individual bankers are relatively rare and primarily reserved for cases of outright fraud, embezzlement, or extreme misconduct. Most enforcement focuses on the corporate entity. While regulators have some powers to ban individuals from banking or levy fines, these are often discretionary and, according to Thomas, "regulators are not really interested in bringing enforcement actions against individual bankers, they don’t see themselves as sort of cops on the street. They see themselves in more of a front end regulatory mode." This institutional bias, combined with a lack of robust mechanisms to hold individuals accountable for negligence that falls short of criminal intent, creates a gap in the deterrence framework.

The Moral Hazard Dilemma: Incentives for Risk-Taking

The concept of "moral hazard" lies at the heart of the University of Michigan team’s critique of current reform proposals. Moral hazard arises when one party is protected from the consequences of a risk, and therefore acts less carefully because someone else will bear the cost. In the context of banking, deposit insurance, and especially the implicit or explicit government bailouts for "too big to fail" institutions, can create perverse incentives for bank executives.

As Thomas articulated, "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."

If bankers know that their institution’s deposits are guaranteed, or that the government will step in to prevent a systemic collapse, the personal financial repercussions for mismanaging risk are significantly reduced. This can lead to executives taking on excessive risk in pursuit of higher short-term profits, knowing that the downside (a bank failure) will largely be socialized—borne by taxpayers, the FDIC insurance fund, or the broader economy—while the upside (large bonuses and stock options from successful risky ventures) is privatized.

This dynamic is particularly acute when considering the proposals to expand deposit insurance. While aiming to prevent runs, such expansion, without a corresponding increase in individual accountability, could inadvertently amplify moral hazard, encouraging even greater risk-taking by executives who feel insulated from personal loss.

A New Paradigm: Personal Accountability for Bank Executives

In their paper, Sanctioning Negligent Bankers, Thomas, Logue, and Zhang advocate for a fundamental shift: bringing "personal accountability back into the picture by pairing regulatory improvements with a credible sanction regime for bank executives." Their proposal is not to dismantle deposit insurance, which they acknowledge has been highly successful in stabilizing the U.S. banking system, but to complement it with a robust "stick" component aimed directly at individuals.

The core of their argument is that while the existing "carrot and stick" system works well in its general design, the "stick" side is currently disproportionately aimed at institutions rather than the decision-makers within them. They propose a civil penalty specifically designed to "disgorge compensation from a bank executive whose negligence substantially increases the risk of a bank collapse."

Deconstructing "Sanctioning Negligent Bankers": The Proposed Framework

The proposed sanction regime is carefully structured to target negligence rather than criminal intent, filling a crucial gap in the existing legal framework. Here are its key features:

Civil Penalty, Not Criminal Punishment: The authors explicitly argue for a civil penalty, distinguishing it from criminal prosecution. This distinction is vital because the burden of proof for criminal charges (beyond a reasonable doubt) is extremely high, making it difficult to prosecute individuals for actions that are negligent but not overtly fraudulent or criminal. A civil standard of negligence (preponderance of the evidence) would be more achievable, allowing for accountability in a broader range of cases where poor judgment or inadequate oversight leads to significant risk.
Focus on Negligence: The regime would target bankers whose "gross negligence" or "reckless disregard" for prudent risk management substantially contributes to a bank’s collapse or near-collapse. This is distinct from mere mistakes or errors in judgment; it aims at a higher degree of culpability where executives failed to exercise the duty of care expected of them.
Automatic Trigger and Enforcement: The proposed enforcement action would "automatically kick in" upon a bank collapse or takeover by the federal government. This automaticity aims to reduce the discretion of regulators, who, as Thomas observed, may be reluctant to pursue individual actions. This mechanism would ensure that an investigation into executive negligence is initiated whenever a failure occurs.
Clawback Mechanism: The primary sanction would be a "clawback" of compensation. Specifically, the sanction would be calculated based on the executive’s earnings over a defined period, such as the past five years. "All the money that you made in your position is going to be clawed back by the government," Thomas explained. This direct financial consequence would create a powerful personal incentive for executives to prioritize long-term stability over short-term, risky gains.
No Insurance Backstop: A critical element of the proposal is that this clawback sanction would be "one without an insurance backstop." This means executives would not be able to rely on D&O (Directors and Officers) insurance policies, which typically cover legal defense costs and settlement payments for civil claims. By removing this layer of protection, the personal financial impact of negligence would be direct and unavoidable, thereby maximizing its deterrent effect.

Drawing Parallels: Banking Crises as Industrial Disasters

To defend the theoretical basis for their approach, the authors draw an insightful analogy: banking crises are akin to industrial disasters. They leverage literature from law and economics concerning optimal enforcement practices for preventing catastrophic events like plane crashes or environmental explosions.

"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 that effective deterrence requires a two-pronged approach:

Corporate Penalties: Incentives for the firm itself to police its own behavior (e.g., fines, regulatory restrictions).
Individual Sanctions: Separate risks or sanctions for individuals within the firm.

The reasoning is that a firm, while it can police its employees to a certain extent, cannot fully internalize the costs of all potential harms. Individuals, especially those in leadership, often have asymmetric information and can take actions that benefit themselves (e.g., higher bonuses) at the firm’s or society’s expense. Without individual accountability, firms might find it cheaper to pay corporate penalties than to strictly monitor and constrain their executives.

"We think that same model actually makes a lot of sense in the banking context. 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," Thomas concluded. This hybrid model, combining institutional oversight with individual responsibility, is seen as crucial for achieving optimal deterrence and greater financial stability.

Distinguishing the Proposal from Existing Measures

The University of Michigan proposal stands apart from existing mechanisms to hold bankers accountable. Current sanctions primarily fall into a few categories:

Criminal Laws: These target egregious acts like fraud, embezzlement, or money laundering. While powerful, they require a high bar of intentional wrongdoing, leaving a significant gap for actions that are grossly negligent but not criminal.
Regulatory Enforcement against Institutions: This includes fines, cease-and-desist orders, and operational restrictions on the bank itself. While impactful for the institution, they often do not directly affect the individual executives who made the critical decisions.
Limited Individual Regulatory Powers: Regulators do possess some powers to remove individuals from banking or impose civil monetary penalties. However, these are often discretionary, subject to political pressure, and, as noted, rarely invoked for negligence short of overt malfeasance. The proposed regime aims to make the application of individual sanctions more systematic and less discretionary.

The crucial distinction lies in the target (individual executives vs. the institution), the standard of proof (negligence vs. criminal intent), and the mechanism of enforcement (automatic clawback vs. discretionary regulatory action). By focusing on civil negligence and an automatic clawback, the authors aim to create a proactive deterrent that makes executives personally responsible for their risk management decisions, without the high evidentiary hurdles of criminal law.

Implementation Considerations and Broader Implications

Implementing such a radical shift in accountability would undoubtedly involve significant legislative and regulatory effort. Congress would need to establish the legal framework, defining "negligence" in the banking context, setting the scope of executives covered, and outlining the process for determining culpability and calculating clawbacks. Regulators would then be tasked with developing detailed rules, investigative procedures, and enforcement guidelines.

One critical challenge would be to precisely define "negligence" in a way that provides clear guidance to bankers without stifling innovation or legitimate risk-taking. Overly broad definitions could lead to an overly cautious banking environment, while overly narrow ones might fail to capture the intended behavior. Another consideration is the potential impact on attracting top talent to the banking sector if the perceived personal risk increases significantly. However, proponents would argue that this might attract more prudent leaders.

The proposal also raises questions about judicial review and the appeals process for executives facing sanctions. Transparency and fairness in the application of the regime would be paramount to its legitimacy.

If successfully implemented, the implications could be profound. Such a regime could foster a culture of heightened personal responsibility within the C-suite, compelling executives to more rigorously oversee risk management practices. It could shift the balance of incentives, encouraging a greater emphasis on long-term stability and sound governance over short-term profits derived from excessive risk. This, in turn, could reduce the likelihood and severity of future banking crises, lessening the burden on taxpayers and strengthening overall financial stability.

The debate surrounding the 2023 banking crisis has underscored the enduring tension between fostering a dynamic financial sector and safeguarding it from systemic risks. The University of Michigan paper offers a compelling and distinct perspective, arguing that true financial stability requires not just institutional oversight, but also a direct and undeniable personal stake for those at the helm. By "shifting more responsibility back onto the decisionmakers in the C-suite," the authors contend, policymakers could finally achieve the financial stability so desperately sought.