The Cost of Market Versus Regulatory Discipline in Banking

The Journal of Financial Economics, June 1998

Posted: 22 Apr 1998

See all articles by Matthew T. Billett

Matthew T. Billett

Indiana University - Kelley School of Business - Department of Finance

Jon A. Garfinkel

University of Iowa - Tippie College of Business

Edward S. O'Neal

Wake Forest University - Babcock Graduate School of Management

Abstract

We present evidence that insured deposit financing shields banks from the full costs of market discipline. Banks experiencing Moody's downgrades exhibit abnormal equity returns that are increasing in the bank's reliance on insured deposits. We also find that banks increase their use of insured deposits after downgrades, consistent with the joint hypothesis that the cost of regulatory discipline is less sensitive to risk changes than the cost of market discipline and banks attempt to minimize the aggregate cost of discipline borne by their shareholders. Our results cast doubt on the ability of capital market participants to effectively discipline bank behavior within the current regulatory environment. More generally, our findings highlight the potential for regulation to undermine market discipline in regulated industries.

Note: This is a description of the paper and not the actual abstract.

JEL Classification: G21, G28

Suggested Citation

Billett, Matthew T. and Garfinkel, Jon A. and O'Neal, Edward S., The Cost of Market Versus Regulatory Discipline in Banking. The Journal of Financial Economics, June 1998. Available at SSRN: https://ssrn.com/abstract=78793

Matthew T. Billett

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3366 (Phone)

Jon A. Garfinkel (Contact Author)

University of Iowa - Tippie College of Business ( email )

108 PBB
Iowa City, IA 52242-1000
United States
319-335-0943 (Phone)
319-335-3690 (Fax)

HOME PAGE: http://www.biz.uiowa.edu/faculty/jgarfinkel

Edward S. O'Neal

Wake Forest University - Babcock Graduate School of Management ( email )

3142 Worrell Professional Center
Winston-Salem, NC 27106
United States
336-758-4976 (Phone)
336-758-4514 (Fax)

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