Accounting Information Quality, Capital Requirements, and Banks' Risk Taking

Abstract

We study the implications of accounting information quality on banks' risk-taking behavior. We show that the accounting information precision has a non-monotonic effect on banks' risk-taking decisions. Surprisingly, when information precision is low, an improvement in precision actually induces banks to take more risk. In addition, the relation between accounting information precision and risk taking is also contingent on the stringency of capital requirement standards and the competitiveness of the banking industry. In particular, when either the capital requirement or the competitiveness of the industry is sufficiently high, increasing accounting information precision restrains risk taking. Moreover, when we consider a liquidation cost of assets sale to fulfill the capital requirement, the effect of the capital requirement on risk-taking behavior becomes more subtle. Specifically, for the capital requirement policy to be an effective tool in disciplining banks' risk-taking behavior, either the banking industry should be highly competitive, or the accounting information should be sufficiently precise.