Stronger Risk Controls, Lower Risk: Evidence from U.S. Bank Holding Companies
In: Market Institutions and Financial Market Risk
In this paper, we investigate whether U.S. bank holding companies (BHCs) with strong and independent risk management functions have lower enterprise-wide risk. We hand-collect information on the organizational structure of the risk management function at the 74 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 exposure to private-label mortgage-backed securities, were less active in trading off-balance sheet derivatives, had a smaller fraction of non-performing loans, and had lower downside risk during the crisis years (2007 and 2008). In a panel spanning the 9 year period 2000--2008, we find that BHCs with higher RMIs have lower enterprise-wide risk, after controlling for size, profitability, a variety of risk characteristics, corporate governance, CEO's pay-performance sensitivity, and BHC fixed effects. This result holds even after controlling for any dynamic endogeneity between risk and internal risk controls. Overall, these results suggest that strong internal risk controls are effective in restraining risk-taking behavior at banking institutions.
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- Demirguc-Kunt, Asli & Detragiache, Enrica, 2002.
"Does deposit insurance increase banking system stability? An empirical investigation,"
Journal of Monetary Economics,
Elsevier, vol. 49(7), pages 1373-1406, October.
- Demirguc-Kunt, Asli & Detragiache, Enrica, 1999. "Does deposit insurance increase banking system stability ? An empirical investigation," Policy Research Working Paper Series 2247, The World Bank.
- Asli Demirguc-Kunt & Enrica Detragiache, 2000. "Does Deposit Insurance Increase Banking System Stability? An Empirical Investigation," Econometric Society World Congress 2000 Contributed Papers 1751, Econometric Society.
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