The last three decades have been characterized byrepeated banking crises (the current financial crisis of 2008, the US savings and loans debacle of the eighties, the 1994-95 Mexican crisis, the 1997 Asian and 1998 Russian financial crises, etc.). Such episodes highlight the inherently unstable nature of banking and the tendency that banks have towards excessive risk-taking. In this paper, we aim to focus on one of the driving forces behind the risk-taking incentives of banks, namely shareholders’ behavior and their incentives to take higher risk. The issue of ownership structure is of particular interest for the banking industry as several factors interact and alter governance, such as the quality of bank regulation and supervision and the opacity of bank assets. Moreover, banking systems faced major changes during the last 20 years.
With financial deregulation and market integration, the scope of activities of banks has been completely reshaped ranging from traditional intermediation products to an array of new businesses. These trends led to a substantial consolidation in the banking industry and consequently to significant changes in ownership and capital structure. Also, institutional ownership of common stock has increased substantially over the past twenty years. In terms of shareholding size, expertise in processing information and monitoring managers, institutional investors (investment companies, investment advisors, pension funds, etc.) are very different from atomistic individual investors. This might also imply changes in corporate governance and in banks’ behavior in terms of risk-taking.
However, it is also well known that for publicly traded banks risk-taking incentives can be mitigated by market forces, and therefore such developments cannot be assessed without considering incentives driven by financial markets in terms of discipline (Bliss and Flannery, 2002; Flannery, 2001). In the new Basel Capital Accord, market discipline is one of three pillars, along with capital regulation (Pillar 1) and banking supervision (Pillar 2). The idea is to rely on market forces to enhance banking supervision and therefore market discipline is expected to play an important role. In this context, our goal is to check if market discipline is actually effective in influencing the risk-taking incentives of different types of shareholders.
To our knowledge there has been no research on whether risk-taking behavior is different in privately owned banks and publicly owned banks under different ownership profiles. Kwan (2004), working on a sample of US bank holding companies (BHC), finds that loan quality and earnings variability are not different between traded BHCs and privately held BHCs. One of our aims is to assess the risk-taking behavior of banks by combining the two interrelated dimensions that are ownership structure and market discipline.
