Effect of Financial Globalization on Bank Risk: Role of Rollover Risk

Abstract

This paper investigates the effects of financial globalization on bank risk by highlighting the role of rollover risk. We extend the canonical rollover risk model by allowing an “active” bank manager to choose excessive risk-taking or systemic risk-shifting actions. Financial globalization is characterized by an increase in investors’ opportunity cost, which affects the coordination problem among short-term creditors, and changes banks’ incentives for risk-taking and systemic risk-shifting. The model generates three predictions and we provide robust empirical evidence to verify them: (1) In the short term, financial globalization will induce those banks with more short-term funding to be more risk-taking; (2) The mid-tier banks are more sensitive to the effects of financial globalization and will become more risk-taking than the rest; and (3) In the long term, financial globalization tends to affect the systemic risk in the financial system, but the precise effects depend on the country’s economic fundamentals and institutional quality.

Keywords: financial globalization; risk-taking; systemic risk-shifting; rollover risk

JEL Classification: F32; G33; G38