The interrelationships between bank risk and market discipline in Southeast Asia

Purpose - The purpose of this study is to examine whether a bidirectional relationship between bank risk and market discipline may exist in Southeast Asia. Design/methodology/approach - A simultaneous equations model with a three-stage least squares estimator is used to examine the interrelationships between bank risk and market discipline using a sample of 79 listed banks in five countries in Southeast Asia (ASEAN-5) from 2006 to 2019. Findings - The findings show a two-way relationship between bank risk and market discipline. In particular, market discipline has a negative impact on bank risk, while there is a positive relationship between bank risk and market discipline. A bidirectional relationship between them still holds when using an alternative measure of bank risk in subsamples, controlling for the global financial crisis and governance indicators. Practical implications - The findings indicate that market discipline can reduce bank risk. Meanwhile, a positive impact of bank risk on market discipline reemphasizes that market discipline is a powerful tool to ensure banks do not have excessive risk-taking. Nonetheless, the findings suggest that further implementation of market discipline as the third pillar of the Basel framework is necessary for the banking systems in ASEAN-5. Originality/value - To the best of the authors’ knowledge, this study is the first attempt to investigate the interrelationship between bank risk and market discipline in Southeast Asia.