Stricter oversight needed as financial misconduct drives risk-taking in banking

Banks facing regulatory sanctions for financial misconduct tend to adopt riskier business practices, according to new research.

The authors warn repeated or systemic misconduct can accelerate risk-taking in ways that weaken both individual institutions and the wider financial system.

Researchers from the University of East Anglia (UEA), the US Department of the Treasury and Bangor University, in the UK, drew on data from nearly 1,000 publicly listed US banks from 1998 to 2023 - a period spanning multiple economic cycles including the 2007–09 financial crisis.

Their findings, published today in the Journal of Banking & Finance, show that banks referred to authorities for violations - ranging from misrepresentation to failures in anti-money-laundering systems - are significantly more likely to engage in risk-heavy strategies and speculative lending.

Board characteristics can make a difference, with larger and more independent boards, particularly those with older or gender-diverse membership, often dampening the negative impact of misconduct. However, if CEOs hold extensive power or if short-term focused institutional investors hold large stakes, even robust boards may struggle to rein in risky behaviour.

Dr Yurtsev Uymaz from UEA’s Norwich Business School said: “We show that enforcement actions and class-action lawsuits against US banks are linked to increased levels of bank risk-taking. Even one enforcement action correlates with higher risk; for banks facing multiple actions, the effect can be markedly stronger.

“There appears to be no deterrent effect from the fact that banks facing multiple actions experience even higher risk.”

Banks play a foundational role in fuelling economic growth. The study authors, including Prof John Thornton of Norwich Business School and the US Department of the Treasury, and Prof Yener Altunbaş of Bangor University, warn unethical conduct that fuels risk-taking can reverberate widely, potentially undermining key forms of credit or amplifying systemic instabilities.

Commenting on the implications for policymakers and stakeholders, such as investors and the public, Dr Yurtsev Uymaz said: “Our findings underscore how lapses in ethical conduct can open the door to riskier practices. This doesn’t just affect a bank’s own stability; it ripples out into the wider economy.

“At the same time, we see that strong governance - embodied in larger, more diverse boards - can help reduce the adverse impacts of misconduct. However, these safeguards can be undermined if CEOs wield too much power or if investors push aggressively for short-term returns.

“Addressing these governance gaps, while also strengthening supervision, is critical to ensuring the banking sector supports sustained economic growth rather than threatens it.”

The study adds to a growing discussion of how misconduct can accelerate systemic risks -especially if fines, reputational damage, and other penalties consume bank resources or divert attention from responsible lending.

The researchers make a number of recommendations, including tighter regulatory oversight and enhanced board accountability.

“Regulators could benefit from deploying extra scrutiny on institutions with even a single documented infraction, rather than solely focusing on banks with persistent or repeated misconduct,” said Prof Thornton.

“Ensuring boards have the independence, capacity, and diversity to challenge powerful executives can help deter strategies motivated by short-term gains but detrimental to long-term stability.

“And regular stress-testing exercises should also explicitly factor in the potential for misconduct-related events, capturing associated legal and reputational costs.”

They add that policymakers might explore incentives or structures that promote longer-term thinking among institutional investors, balancing out near-term profit goals with systemic safety.

‘Financial misconduct and bank risk-taking: evidence from US banks’, John Thornton, Yener Altunbaş and Yurtsev Uymaz is published in Journal of Banking & Finance on March 31.