German banking game riskier with go to jail card

Negligent bankers could end up behind bars in Germany if a proposed bill passes. It is motivated by the current electoral climate and raises legal issues. However, the threat of imprisonment might be an effective deterrent to limit reckless behaviour in the financial industry.

Risk-addicted bankers in Germany could soon face a new occupational hazard: jail. Angela Merkel’s government is pushing for a bill that will make it easier to put failed bankers behind bars. The proposed legislation targets excessive risk-taking by financial professionals who neglect their duty of care and endanger the future of their institution: they would be committing a criminal offence and could face up to five years in jail.

The proposal is easy to criticise. First, it smells of populism, coming as it does in the middle of a hard-fought electoral campaign. Angela Merkel is facing a general election in September, and her social democratic challenger, Peer Steinbrueck, is campaigning for tougher banking regulation. Merkel is clearly trying to steal his thunder.

Second, the new law hinges on vague legal concepts and creates vast judicial uncertainty. The courts will ultimately have to define opaque financial and legal concepts – like what constitutes “appropriate” risk management. Furthermore, it will be difficult to discern with hindsight if excessive risks were clearly discernible ex ante. No wonder it is unclear whether anyone would have gone to jail if the law had been in place before the financial crisis.

Yet there is something in the idea of taming bankers through criminal laws. Recent financial history has shown the dangers of the moral hazard contained in the “too big to fail” orthodoxy. Implicit state guarantees foster excessive risk-taking. When the bets work out, bankers are rewarded handsomely. When they fail, the public picks up the pieces. Regulators and policymakers are working to tighten the rules and reduce the guarantees for banks. But the jury is still out on whether ring-fencing risky operations, or resolution schemes, will work in reality.

The prospect of jail might be more effective in changing bankers’ behaviour because it alters the whole system of personal incentives. It creates a negative, personal form of retribution for those actions that have an adverse impact on the public at large and require the use of taxpayers’ money. If technical and legal obstacles can be overcome, such a law will make bankers pause before they charge ahead. Speed limits always reduce the number of fatal accidents.

This article was initially  published as a Reuters Breakingviews comment on 11 February 2013.


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