The Effect of Industrial Sector Transparency on Bank Risk-taking and Banking System Fragility

72 Pages Posted: 31 Aug 2012 Last revised: 4 Jan 2013

See all articles by Sudarshan Jayaraman

Sudarshan Jayaraman

University of Rochester - Simon Business School

S.P. Kothari

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: August 29, 2012

Abstract

We show real effects in the banking sector that emanate from transparency in the industrial sector. Transparent financial reporting by industrial firms facilitates access to arm’s-length financing from capital markets and diminishes these firms’ reliance on banks. Banks, as a result, face increased competition in their product markets and seek to offset their lost rents by – (i) taking on more risk, (ii) reducing their cost structures and (iii) increasing the intensity of intermediation. The net effect of these activities is to lower the likelihood of a banking crisis in countries with greater borrower transparency. Additional tests suggest that risk-taking is channeled more through non-lending than lending activities, pointing to the beneficial role of diversification in reducing bank fragility. Tests using the mandatory adoption of International Financial Reporting Standards (IFRS) as a shock to borrower transparency indicate that endogeneity is unlikely to be driving our findings. A difference-in-differences design shows that risk-taking, cost efficiency and bank intermediation in banks of IFRS adopting countries are more salient than those in non-adopting countries. Overall, we provide novel evidence that transparency of the industrial sector strengthens the banking sector.

Keywords: Transparency, banks, risk-taking, crises, bank fragility

JEL Classification: G21, M41

Suggested Citation

Jayaraman, Sudarshan and Kothari, S.P., The Effect of Industrial Sector Transparency on Bank Risk-taking and Banking System Fragility (August 29, 2012). Available at SSRN: https://ssrn.com/abstract=2138156 or http://dx.doi.org/10.2139/ssrn.2138156

Sudarshan Jayaraman (Contact Author)

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

S.P. Kothari

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

E52-325
Cambridge, MA 02142
United States
617-253-0994 (Phone)
617-253-0603 (Fax)

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