The determinants of bank risks: evidence from the recent financial crisis

Leung, W.S., Taylor, N. and Evans, K.P. (2015) The determinants of bank risks: evidence from the recent financial crisis. Journal of International Financial Markets, Institutions and Money, 34, 277-293. (doi:10.1016/j.intfin.2014.11.012).

Abstract

We investigate whether US bank holding company fundamental characteristics are related to bank risk over a period that covers the recent 2007–09 financial crisis. We extend prior studies to consider bank equity risk exposure to market-wide default risk, the structured finance market, and the asset-backed money market in a variance decomposition. Four important results emerge: (1) the risk in bank opaque assets is not accurately priced; (2) banks with lower earnings have higher risk; (3) a positive relationship between non-performing loans and bank risk increased threefold during the crisis and (4) banks with a larger buffer of Tier 1 capital have lower risk and lower exposure to shocks in market-wide default risk and the structured finance market in particular. These results highlight the importance to investors of studying fundamentals, while from a bank regulatory perspective, effective management of regulatory capital may manage risks arising from contagion stemming from structured finance markets and funding illiquidity.

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Contributors

Author: W.S. Leung

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