Bank Herding and Incentive Systems as Catalysts for the Financial Crisis

Why do good bankers at times respond unanimously with the same disastrous strategy? Rooted in regulatory economics and behavioural finance, the paper offers a taxonomy of effects that narrow banks decision scope into funnel-shaped and thus prepared the ground for the financial crisis. The basic message of the paper is that inconsistent decision rules, too rigid bank regulation, stakeholder-shaped incentive structures within banks and uncritical adoption of innovations may force banks into decisions that are micro-functional but macro-dysfunctional. Behavioral aspects play a key role in the suggest remedies on the regulatory side (macroprudential regulation, supervision of incentives) and on the banking side (proper reward systems and structured decision making) to re-establish prudent banking