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Regulatory and governance impacts on bank risk-taking

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Abstract

Risk in financial institutions is vitally important to regulators, policy makers, investors, and the stability of the financial system, yet some critical aspects of that risk remain poorly understood. In the case of U.S. startup banks, a critical choice that can influence risk-taking behavior is which of three regulators—with varying levels of stringency—to choose. The board of directors of the new bank makes this important decision, which may result in different risk implications, depending on board’s structure. Here, we examine banks’ risk behavior associated with the degree of board independence and the choice of regulator. We find that the regulatory environment and board independence jointly influence new bank risk. Our evidence suggests that the intensity of regulatory scrutiny is a partial substitute for board independence in achieving an optimal level of risk. We discuss the implications of our findings for theory and policy.

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Notes

  1. ‘Optimum’ within the constraints that remain, e.g., the agency costs that exist at all levels of the firm (Jensen and Meckling 1976).

  2. The magnitude of the differences in regulatory stringency is corroborated by information from the policy statements of these agencies. For example, FDIC banks are required to maintain a ratio of capital to assets of at least 8% during their first 3 years of operations, while similar OCC banks are only required to be ‘well capitalized’ during the same period, standards that allow these banks to maintain a ratio of capital to assets of as low as 4%.

  3. Director ownership is often included either as a control variable or a variable capturing the incentives of outside directors to monitor management. In our study, this variable is unavailable, as these are private firms whose director ownership is not disclosed. However, in most startup banks, all directors have some level of ownership stake, and the bank is closely held and owner-managed (Myers 2004).

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Authors and Affiliations

  1. Department of Management, Trulaske College of Business, University of Missouri, Columbia, MO, 65211-2600, USA

    Karen Schnatterly

  2. Department of Management, College of Business Administration, University of Nebraska Omaha, Omaha, NE, 68106, USA

    Brent B. Clark

  3. Department of Finance, Trulaske College of Business, University of Missouri, Columbia, MO, 65211-2600, USA

    John Howe

  4. Opus College of Management, University of St. Thomas, 1000 LaSalle Ave, Minneapolis, MN, 55403, USA

    Michael L. DeVaughn

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  1. Karen Schnatterly
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Correspondence to Brent B. Clark.

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Schnatterly, K., Clark, B.B., Howe, J. et al. Regulatory and governance impacts on bank risk-taking. Risk Manag 21, 99–122 (2019). https://doi.org/10.1057/s41283-018-0044-1

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