Measuring the Risk Appetite of Bank Controlling Shareholders: The Risk-Weighted Ownership

Abstract

In this paper, we propose a measure of the risk appetite of a bank's ownership structure and investigate whether ownership risk propensity is correlated with performance and default risk. Our indicator, the Risk-Weighted Ownership (RWO), assumes that credit risk is a proxy for the risk appetite of shareholders and assigns a Basel standard approach risk weights to the stakes held by the top five, 10, and 20 controlling shareholders. We compute the RWO index on a sample of 76 listed banks based in the Eurozone and the United Kingdom, covering the 2008–2017 timespan. We regress the RWO with accounting- and market-based performance and risk measures and find that it correlates with bank fundamentals. We document two main findings. First, the RWO index incorporates the risk appetite of controlling shareholders, and its variance depends on the ownership structure’s composition. Second, a higher shareholders’ risk appetite is associated with higher profitability but lower bank capitalization, entailing a trade-off between performance and default risk. Overall, we find that the risk appetite of the ownership structure is an important driver of bank performance and risk.

Keywords: bank, ownership, risk appetite, corporate governance