Bank Restatements and Financial System Stability

Abstract

This paper investigates whether and how restatements in banks affect financial system stability. I find that banks contribute more to systemic risk up to four quarters after a restatement, and that the restatement effect on systemic risk is larger for banks that (i) are very interconnected to other banks, (ii) rely heavily on short-term funding, and (iii) experienced severely negative market reactions to the restatement. These findings suggest that the uncertainty following bank restatements spills over to the system through the overlapping claims between financial institutions (liability side), not through positively correlated risk factors on banks' balance sheets (asset side).

Keywords: Earnings restatements; Bank transparency; Bank stability; Financial contagion; Instrumental variables

JEL Classification: G14; G21; M41; M48