The prospects of using market information for the identification of risk in banking organizations have become a focus of bank supervision in recent years. This concern has arisen in part because of the rapid growth of large, global banking organizations whose portfolios and global operations have become increasingly complex in scope and increasingly opaque to supervisors and financial markets.
In this regard, bank supervisors are attempting to glean any information that may assist them in identifying the changing risk structures of these firms. This interest in turning to markets for assistance has been accelerated by empirical research that suggests bank supervision might benefit from using information embedded in the capital market valuation of banking organizations' debt and equity securities.
This work has found that financial market information can be used to supplement and complement the traditional supervisory practices of on-site examinations and off-site monitoring. If markets are meaningfully efficient and investors are able to monitor and/or anticipate emerging risks of organizations, then investors' expectations become embedded in financial market information. Market assessment and the pricing of risky management policies may restrain risky behavior (direct market discipline) and/or assist supervisors in the monitoring process by providing timely signals on the changing risk patterns of these firms (indirect market discipline).
The potential use of the signaling features of markets for modern bank supervision and discipline offers promise, as evidenced by the calls for including market indicators into the supervisory process that are being voiced at the highest levels of the U.S. bank regulatory agencies and the U.S. Congress and, on the international front, by the Basel Committee on Bank Supervision.
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Market Information, Bank Holding Company Risk, and Market Discipline
