The stricter surveillance required to promote risk-taking in banking, research says

New research shows that banks facing regulatory sanctions for financial fraud are more likely to adopt risky business practices.

The authors warn that repetitive or systemic misconduct can accelerate risk taking in ways that undermine both individual institutions and the broader financial system.

Researchers at the University of East Anglia (UEA), UK’s US Treasury and Bangor University discussed data spanning multiple economic cycles, including the 2007-09 financial crisis, from nearly 1,000 US banks between 1998 and 2023.

Their findings published in the Journal of Banking & Finance show that the bank has referred the authorities for the violation. This indicates that there is a very high chance of engaging in high-risk strategies and speculative lending, ranging from misrepresentation to failure of anti-money laundering systems.

Board characteristics often weaken the negative effects of fraud on larger, more independent boards, especially those with older or gender diversity memberships.

However, if CEOs hold widespread power, or if short-term institutional investors hold large stakes, even robust committees can struggle to curb risky behaviour.

“We show that enforcement actions and class actions against U.S. banks are linked to an increased level of risk taking for banks. Even one enforcement action correlates with higher risk,” said Dr Yurtsev Uymaz of Norwich Business School in the UEA.

“It does not seem to have a deterrent effect from the fact that banks facing multiple actions are experiencing even higher risks.”

Banks play a fundamental role in driving economic growth. Research authors, including Professor John Thornton of Norwich Business School and the US Bureau of the Treasury, and Professor Yenar Altumba of Bangor University, warn that the unethical conduct that risk-taking could be a widespread repercussion, could undermine key forms of trust and amplify systemic instability.

Commenting on the impact on policymakers and stakeholders, including investors and the public, Dr. Yurtsev Uymaz said:

“At the same time, we see strong governance, wrapped in larger, more diverse committees, helps reduce the negative impact of fraud, but if CEOs perform too much power or investors push forward with short-term returns, these safeguards could undermine these protections.

“Dealing with these governance gaps is also important to strengthen oversight, while supporting sustainable economic growth, rather than threatening it.”

The study has seen an increasing debate on how fraud can accelerate systemic risk, particularly when fines, reputational damage, and other penalties consume bank resources or distract attention from responsible lending.

Researchers make many recommendations, including stricter regulatory oversight and increased board accountability.

“Regulators can benefit from deploying extra scrutiny on the institution, not just on the banks, even a single documented violation,” Professor Thornton said.

“Ensuring independence, ability and diversity to challenge strong executives can help prevent strategies that are motivated by short-term benefits but are detrimental to long-term stability.

“And regular stress testing exercises should explicitly consider the possible events related to fraud and acquire relevant legal and reputation costs.”

They added that policymakers may explore incentives and structures that encourage long-term thinking among institutional investors, balancing short-term profit targets with systematic safety.