Market Discipline and Bank Risk

Abstract

This paper empirically examines the impact of market discipline on bank risk taking. Using a sample of 321 financial institutions from the Group of Seven nations (G7) comprising Canada, France, Germany, Italy, Japan, the UK, and the US, over the period 1996-2010, our findings suggest that market discipline helps reduce equity risk and credit risk of banks. We also find that the negative impact of market discipline on bank risk is stronger: in the presence of a risk-adjusted insurance premium, as bank capital increases and in the post-global financial crisis period. The results are robust to alternative estimation techniques.

Keywords: market discipline, bank risk, global financial crisis

JEL Classification: G21, G32