Risk taking behavior of banks, ownership structures and effect of regulations on franchise value and efficiency: empirical evidence from US Banking Sector.

Abstract

Regulators, researchers and academia have long held their deep-rooted interest in the characteristics of financial institutions, which have experienced their share of crises in the past half century. The recent wave of crises that started following sub-prime mortgage crises of 2008 subsequently led to global recession and resulted in stringent regulations requiring banks and financial institutions to comply with directives from International bodies as well as national regulators. Despite the severity of its consequences on the real estate sector and financial institutions, the impact on the financial industry has not been fully explored in terms of interlinkages between risk-taking, derivative usage, ownership structures, regulations, efficiency and franchise value. The thesis comprises of three essays: the first essay is based on dynamic panel methodology investigating effect of bank stability, ownership structure and capital regulations on efficiency of US BHCs employing interactive variables for ownership structure and stability. The results show that BHCs with higher stability are typically more efficient. Regarding the ownership structure, BHCs with higher proportion of institutional ownership especially those exerting the market discipline such as the mutual funds and hedge funds positively affect the efficiency of BHCs. On the other hand, higher levels of government ownership adversely impact the efficiency of BHCs. Overall empirical findings support the regulatory view that higher stability levels and close monitoring by shareholders help in improving the efficiency. The focus of the second essay is an analysis of the impact that ownership structure, stability, competition and capital regulations would have on franchise value of US BHCs. My results show that BHCs with the higher stability enjoy higher franchise value. Higher institutional investment is associated with higher franchise value in line with arm-length owner-manager relationship hypothesis and the ability to sell the underperforming banks. On the contrary, BHCs with higher family ownership have lower franchise values indicating the existence of agency problem. Though maintaining higher capital buffers alone did not significantly influence franchise value of BHCs, however, capital regulations when used interactively with ownership structure are found to have a moderating effect on franchise value of US BHCs. The results indicate that increase in the capitalization moderates marginal effect of both family as well as institutional ownership on franchise value negatively. The third essay in the series focuses on the issue of how the decision to transact in derivatives and ownership structure would shape the risk-taking behavior of US BHCs. The empirical findings suggest that ownership structure affects stability of US BHCs and higher ownership concentration with financial institutions that manage assets on behalf of their clients such as mutual fund, hedge/equity fund, corporations, real estate, structured fund and Union fund, trust and endowment companies are associated with lower stability as compared with those BHCs with a higher level of government ownership. The empirical results indicate that the using credit derivatives results in higher stability and supports the hedging vii hypothesis. Meanwhile, interest rate derivative and foreign exchange derivative usage decreases the stability of US BHCs supporting the substitution hypothesis. Overall, the empirical results reveal how the risk-taking behavior, propensity to use derivatives and ownership structure of US BHCs are connected. This thesis has important implications for regulators, governments and different categories of owners. Regulators can also find these results valuable in understanding the risk appetites of family, government and institutional investors and their effects on stability, efficiency and franchise value of BHCs. The study concludes that understanding of the ownership structure, stability, capitalization in the purview of efficiency and franchise value are important for regulators especially at the macro-economic level and while framing regulations to check the risk-taking by banks.