How do banks make the trade-offs among risks? The role of corporate governance

This study analyzes the role of corporate governance in the relationship among credit, interest rate, and liquidity risks encountered by banks. In particular, the study investigates how banks make the trade-offs among these risks under the maturity transformation business model. The sample consists of banks in 43 countries over the period of 2002–2010. Results show that credit, interest rate, and liquidity risks are related to one another, and that the interactions among them can be reduced by corporate governance and regulations. During the regular yield curve spread (YCS) period, management-controlled banks take less credit risk and even less liquidity risk whereas shareholder-controlled banks encounter more liquidity risk as they pursue more interest rate risk. During the inverted YCS period, management-controlled banks still opt for less credit risk-taking, but shareholder-controlled banks are greatly exposed to risks and should thus be monitored by concerned authorities.