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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.

Suggested Citation

  • Andrew Ellul & Vijay Yerramilli, 2010. "Stronger Risk Controls, Lower Risk: Evidence from U.S. Bank Holding Companies," FMG Discussion Papers dp646, Financial Markets Group.
  • Handle: RePEc:fmg:fmgdps:dp646
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    References listed on IDEAS

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    1. 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.
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    Cited by:

    1. 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.
    2. Biais, Bruno & Rochet, Jean-Charles & Woolley, Paul, 2013. "The dynamics of innovation and risk," TSE Working Papers 13-448, Toulouse School of Economics (TSE).
    3. Rüdiger Fahlenbrach & Robert Prilmeier & René M. Stulz, 2012. "This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance during the Recent Financial Crisis," Journal of Finance, American Finance Association, vol. 67(6), pages 2139-2185, December.
    4. Calomiris, Charles W. & Carlson, Mark, 2016. "Corporate governance and risk management at unprotected banks: National banks in the 1890s," Journal of Financial Economics, Elsevier, vol. 119(3), pages 512-532.
    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. Huizinga, Harry & Laeven, Luc, 2012. "Bank valuation and accounting discretion during a financial crisis," Journal of Financial Economics, Elsevier, vol. 106(3), pages 614-634.
    7. Patrick Bolton & Hamid Mehran & Joel Shapiro, 2015. "Executive Compensation and Risk Taking," Review of Finance, European Finance Association, vol. 19(6), pages 2139-2181.
    8. Manganelli, Simone & Altunbas, Yener & Marqués-Ibáñez, David, 2011. "Bank risk during the financial crisis: do business models matter?," Working Paper Series 1394, European Central Bank.
    9. Acharya, Viral & Naqvi, Hassan, 2012. "The seeds of a crisis: A theory of bank liquidity and risk taking over the business cycle," Journal of Financial Economics, Elsevier, vol. 106(2), pages 349-366.
    10. 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.
    11. 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," Working Papers 12-13, Federal Reserve Bank of Philadelphia.
    12. Bruno Biais & Florian Heider & Marie Hoerova, 2016. "Risk-Sharing or Risk-Taking? Counterparty Risk, Incentives, and Margins," Journal of Finance, American Finance Association, vol. 71(4), pages 1669-1698, August.
    13. 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.
    14. Aebi, Vincent & Sabato, Gabriele & Schmid, Markus, 2012. "Risk management, corporate governance, and bank performance in the financial crisis," Journal of Banking & Finance, Elsevier, vol. 36(12), pages 3213-3226.
    15. Cihak, Martin & Demirguc-Kunt, Asli, 2013. "Rethinking the state's role in finance," Policy Research Working Paper Series 6400, The World Bank.
    16. Kenneth R. Spong & Richard J. Sullivan, 2012. "Bank Ownership and Risk Taking: Improving Corporate Governance in Banking after the Crisis," Chapters,in: Research Handbook on International Banking and Governance, chapter 7 Edward Elgar Publishing.
    17. René M. Stulz, 2014. "Governance, Risk Management, and Risk-Taking in Banks," NBER Working Papers 20274, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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