Banks are fundamental in increasing competitiveness of small, open economies that have underdeveloped capital markets. However, when the same banks are encountered by the wrong incentives that lead to excessive risk taking the resulting outcomes are not only ruinous for their shareholders, but are also capable of disrupting the entire financial stability, even endangering regional economies. This article centres on both the institution specific internal governance related incentives for

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... e risk taking and systemic incentives. In small, open economies, the most notable examples of the former category are weak internal control functions or poorly informed and insufficiently trained senior management, and inadequate compensation schemes. Systemic incentives for excessive risk taking, on the other hand, are arising from the specificities of legislative and regulatory framework and actions of external agents such as herding behaviour by peer-banks, biased bail out possibilities and regulatory arbitrage issues, high tolerance level of depositors and legislative deficiencies (limited liability of banks, tax shields for corporate debt). This article also looks at the resulting outcomes from excessive risk taking -whether the risk taking increased the shareholder value and what are the effects for the financial stability, direct and indirect costs to the taxpayers and local economy as a whole. The issues shown in this article are crucial for further development of the regulation for the banking sector, as well as for making future investment related decisions and formulation of banks' risk appetite frameworks. The analysis in the article is conducted by statistical and market analysis, literature review, document examination of prudential and supervisory regulation.