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Stronger Risk Controls, Lower Risk: Evidence from U.S. Bank Holding Companies

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  • Andrew Ellul
  • Vijay Yerramilli

Abstract

In this paper, we investigate whether U.S. bank holding companies (BHCs) with strong and independent risk management functions had lower aggregate risk and downside risk. We hand-collect information on the organization structure of the 75 largest publicly-listed BHCs, and use this information to construct a Risk Management Index (RMI) that measures the strength of organizational risk controls at these institutions. We find that BHCs with a high RMI in the year 2006, i.e., before the onset of the financial crisis, had lower exposures to mortgage-backed securities and risky trading assets, were less active in trading off-balance sheet derivatives, and generally fared better in terms of operating performance and lower downside risk during the crisis years (2007 and 2008). In a panel spanning 8 years, we find that BHCs with higher RMIs had lower aggregate risk and downside risk, and higher stock returns, after controlling for size, profitability, a variety of risk characteristics, corporate governance, executive compensation, and BHC fixed effects. This result holds even after controlling for any simultaneity bias. Overall, these results suggest that strong internal risk controls are effective in lowering risk at banking institutions.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/dp646AXA1.pdf
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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp646.

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Date of creation: Feb 2010
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Handle: RePEc:fmg:fmgdps:dp646

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Web page: http://www.lse.ac.uk/fmg/

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Cited by:
  1. Altunbas, Yener & Marqués-Ibáñez, David & Manganelli, Simone, 2011. "Bank risk during the financial crisis: do business models matter?," Working Paper Series 1394, European Central Bank.
  2. Silva Buston, C.F., 2013. "Active Risk Management and Banking Stability," Discussion Paper 2013-068, Tilburg University, Center for Economic Research.
  3. Biais, Bruno & Heider, Florian & Hoerova, Marie, 2012. "Risk-sharing or risk-taking? Counterparty risk, incentives and margins," Working Paper Series 1413, European Central Bank.
  4. Acharya, Viral V & Naqvi, Hassan, 2012. "The Seeds of a Crisis: A Theory of Bank Liquidity and Risk-Taking over the Business Cycle," CEPR Discussion Papers 8851, C.E.P.R. Discussion Papers.
  5. Anginer, Deniz & Demirguc-Kunt, Asli & Huizinga, Harry & Ma, Kebin, 2013. "How does corporate governance affect bank capitalization strategies ?," Policy Research Working Paper Series 6636, The World Bank.
  6. Rüdiger Fahlenbrach & Robert Prilmeier & René M. Stulz, 2011. "This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance During the Recent Financial Crisis," NBER Working Papers 17038, National Bureau of Economic Research, Inc.
  7. Joseph P. Hughes & Loretta J. Mester, 2012. "A Primer on Market Discipline and Governance of Financial Institutions for Those in a State of Shocked Disbelief," Departmental Working Papers 201204, Rutgers University, Department of Economics.
  8. Cihak, Martin & Demirguc-Kunt, Asli & Johnston, R. Barry, 2013. "Incentive audits : a new approach to financial regulation," Policy Research Working Paper Series 6308, The World Bank.
  9. Hamid Mehran & Alan Morrison & Joel Shapiro, 2011. "Corporate governance and banks: what have we learned from the financial crisis?," Staff Reports 502, Federal Reserve Bank of New York.
  10. Anderson, Ronald W. & Jõeveer, Karin, 2012. "Bankers and bank investors: Reconsidering the economies of scale in banking," CEPR Discussion Papers 9146, C.E.P.R. Discussion Papers.
  11. Cihak, Martin & Demirguc-Kunt, Asli, 2013. "Rethinking the state's role in finance," Policy Research Working Paper Series 6400, The World Bank.

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