Are bank shareholders enemies of regulators or a potential source of market discipline?

Abstract: In moral hazard models, bank shareholders have incentives to transfer wealth from the deposit insurer--that is, maximize put option value--by pursuing riskier strategies. For safe banks with large charter value, however, the risk-taking incentive is outweighed by the possibility of losing charter value. Focusing on the relationship between book value, market value, and a risk measure, this paper develops a semi-parametric model for estimating the critical level of bank risk at which put option value starts to dominate charter value. From these estimates, we infer the extent to which the risk-taking incentive prevailed during 1986-92, a period characterized by serious banking problems and financial turmoil. We find that despite the difficult financial environment, shareholders' risk-taking incentive was confined primarily to a small fraction of highly risky banks.

Keywords: Stockholders; Bank supervision; Bank management; bank risk; charter value; risk-taking; moral hazard;

JEL Classification: G21; G28;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2001-09-01

Number: 138

Note: For a published version of this report, see Sangkyun Park and Stavros Peristiani, "Are Bank Shareholders Enemies of Regulators or a Potential Source of Market Discipline?" Journal of Banking and Finance 31, no. 8 (August 2007): 2493-515.