Did Governance Fail Universal Banks? Moral Hazard, Risk Taking and Banking Crises in Interwar Italy

In interwar Italy, at least six major episodes of banking crises required the intervention of monetary authorities to bail out, restructure, or liquidate distressed intermediaries. The five large universal banks rescued in the systemic crisis of 1930-1 jointly accounted for one-third of the total assets of the banking system. What made Italian leading banks so prone to crises? This article suggests that their fragility was ultimately caused by governance failures, both public and private, that enhanced excess risk-taking. Empirical evidence is consistent with theoretical insights according to which the potential for moral hazard and conflict of interest, endemic in universal banking, can be magnified when banks enter into long-run relationships with firms and base their growth strategy on the pursuance of monopolistic rents. Interwar Italy emerges as a case in which an insider system devoid of the disciplinary devices provided by sound governance institutions created perverse incentives and weakened the resilience of the banking system to adverse macroeconomic shocks.

Did Governance Fail Universal Banks? Moral Hazard, Risk Taking and Banking Crises in Interwar Italy Articles