Stronger Risk Controls, Lower Risk: Evidence from U.S. Bank Holding Companies
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.
We would like to thank Rajesh Aggarwal, Utpal Bhattacharya, Charles Calomiris, Mark Carey, Michel Crouhy, Mark Flannery, Laurent Fresard, Bill Keeton, Radhakrishnan Gopalan, Nandini Gupta, Jean Helwege, Christopher Hennessy, Tullio Jappelli, Steven Kaplan, Anil Kashyap, Jose Liberti, Marco Pagano, Rich Rosen, Amit Seru, Phil Strahan, René Stulz, Anjan Thakor, David Thesmar, Greg Udell, James Vickery, Vikrant Vig, Jide Wintoki, and seminar participants at the CEPR Summer Symposium in Gerzensee, European School of Management and Technology (Berlin), Indiana University, the NBER Sloan Project Conference on Market Institutions and Financial Market Risk and our discussants Charles Calomiris and Michel Crouhy, the Southwind Finance Conference at the University of Kansas and our discussant Bill Keeton, and University of Naples Federico II for their helpful comments and suggestions. We also thank our research assistants, Robert Gradeless and Shyam Venkatesan,for their diligent effort. All remaining errors are our responsibility. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Stronger Risk Controls, Lower Risk: Evidence from U.S. Bank Holding Companies, Andrew Ellul, Vijay Yerramilli. in Market Institutions and Financial Market Risk, Carey, Kashyap, Rajan, and Stulz. 2012
ANDREW ELLUL & VIJAY YERRAMILLI, 2013. "Stronger Risk Controls, Lower Risk: Evidence from U.S. Bank Holding Companies," The Journal of Finance, vol 68(5), pages 1757-1803.