Are the Largest Banking Organizations Operationally More Risky?

Abstract

This study demonstrates that, among large U.S. bank holding companies (BHCs), the largest ones are exposed to more operational risk. Specifically, they have higher operational losses per dollar of total assets, a result largely driven by the BHCs’ failure to meet professional obligations to clients and/or faulty product design. Operational risk at the largest institutions is also found to: (i) be persistent, (ii) have a counter-cyclical component (higher losses occur during economic downturns), and (iii) materialize through more frequent tail-risk events. We illustrate three plausible channels linking BHC size and operational risk – institutional complexity, moral hazard incentives arising from “too-big-to-fail” and innovation. Our findings have important implications for large banking organization performance, risk, and supervision.

Keywords: banking organizations, size, operational risk, tail risk, recessions

JEL Classification: G20, G21