Bank regulation, governance and the crisis: a behavioral finance view

Abstract

Purpose -The purpose of this paper is to analyze the 2008-2009 financial crisis using a behavioral view, and suggest changes in government policy and company governance to deal with the key behavioral problems. Design/methodology/approach -Behavioral elements of the crisis are identified and explained, intermediaries involved in the crisis are reviewed, and both financial institution strategies and public policies are presented to deal with each element. Findings -The behavioral view of the financial market points out that over-optimism, anchoring, hubris and herd behavior are human attributes, and that future crises involving excessive credit extension will occur because of such non-rational behavior. Responses to these elements of the crisis focus on four points: overconfidence related to rising home prices; inability of the market to channel participant behavior in sustainable directions; inadequate financial institution management due to hubris and herd behavior; and inadequate regulation due to regulatory capture and information gaps. Practical implications -Policymakers must see that no policy can eliminate future crises, so they should focus on designing responses to the behaviors of market participants. Raising levels of capital adequacy will help convince the market that the environment is safer, but ultimately new crises will occur anyway. Policy should aim to pre-establish responses to those future asset price bubbles and market-failure conditions. Practitioners must recognize the realities of overconfidence and herd behavior, to design better management that will constrain overextension of credit and excessive risk-taking. Originality/value -A behavioral view has not previously been applied systematically to explain the crisis and to develop responses to it.

Effect of Cognitive Biases on Investment Decision Making: A Case of Pokhara Valley, Nepal

“…Investors' decision-making cannot solely be based on conventional finance of an efficient market model (Sharma, 2016). Behavioral finance revolved as a new phenomenon for understanding the investors' decision-making tendency towards investments made in different areas such as banks and financial institutions, educational institutions, manufacturing, and service sectors (Grosse, 2012;Pompian, 2012). Behavioral finance integrates cognitive psychology and limits arbitrage theory with traditional finance to explain why individuals make illogical decisions.…”

Conclusion: Public Policy Theory and Democracy: The Elephant in the Corner

“…The Dodd-Frank banking reform law required regulators to write hundreds of rules and conduct dozens of studies within agencies before the laws reforms could be put in place. The result of all the nearly invisible activity has been delays, weak rules, and regulatory setbacks (Grosse 2012 ).…”

Constructing the GFC: Australian banking leaders during the financial ‘crisis’

“…The emergence of the GFC in 2007 stimulated numerous accounts of the role of leadership in bringing about the crisis. Banking leaders are said to have demonstrated hubris and greed in their blind faith in modern finance and the infallibility of their complex financial models (Grosse, 2012; Weitzner and Darroch, 2009). Their confidence is believed to have fuelled excessively risky behaviours, which were incentivised by performance-based compensation (Bebchuk et al., 2010; Bhagat and Bolton, 2014).…”