Stronger Risk Controls, Lower Risk: Evidence from U.S. Bank Holding Companies

TLDR: In this paper, the authors investigated whether cross-sectional dierences across U.S. bank holding companies (BHCs) can be explained by dierences in the organizational structure of their risk management functions.

Abstract: There were signicant cross-sectional dierences across banks in their risk-taking behavior prior to, and the losses they suered during the recent nancial crisis. In this paper we investigate whether these cross-sectional dierences across U.S. bank holding companies (BHCs) can be explained by dierences in the organizational structure of their risk management functions. We hand-collect information on the risk management function at the 74 largest publicly-listed BHCs, and construct a Risk Management Index (RMI) to measure the strength of BHCs’ organizational risk controls. We nd that BHCs with a high RMI before the onset of the nancial crisis had lower exposure to private-label mortgage-backed securities and o-balance sheet derivatives, lower fraction of non-performing loans and lower downside risk during the crisis years. In a panel spanning 2000{2008, we nd a strong and robust negative association between BHCs’ enterprise risk and lagged RMI, all else equal. Overall, these results suggest that strong internal risk controls may be eective in restraining risk-taking behavior at banking institutions.