The Cost of Market Versus Regulatory Discipline in Banking
The Journal of Financial Economics, June 1998
Posted: 22 Apr 1998
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: Suggested Citation