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By Ronald Fink
A noted finance expert called for the end to limited liability for bank shareholders in an article posted on the website Institutional Risk Analyst on Saturday. Edward Kane, a finance professor at Boston University and a senior fellow at the Federal Deposit Insurance Corporation Banking Research Center, said such a move would be the most effective way to rein in the incentives bank shareholders now have to maximize their returns without sufficient regard to risk.
"Extended stockholder liability makes stockholders of a liquidating firm responsible for covering a layer of corporate losses beyond the value of the capital previously accumulated at the corporate level," Kane wrote.
Currently, bank shareholders' losses, like those of other publicly traded companies, are limited to the value of their capital. But owners of U.S. banks were personally on the hook for twice that amount until the late 19th century. In the United Kingdom and Canada, bank shareholders faced unlimited liability until that was limited around the same time.
Kane did not say what limit should now be applied but asserted that some degree of extension was in order. "Extended liability increases transparency, counterparty disciplinary rights, and regulatory accountability at the same time. It increases transparency by transforming movements in the stock price of publicly traded banks into a clearer signal of institutional strength or weakness."
Kane argued that such a signal to the market would prevent the liquidity panics that caused troubled financial institutions to implode during the recent credit crisis, requiring government bailouts.
"Because doubts would emerge gradually, these 'runs' on an institution's stock would be far less catastrophic than the sudden meltdowns that inattentive regulators allowed Bear Stearns, Fannie Mae, Freddie Mac, and Lehman Brothers to experience in 2008," the researcher wrote.
Kane is also a visiting scholar at the Federal Reserve Bank of San Francisco and is a former president of the North American Economics and Finance Association.
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