Checking the Box: Does Compliance with Risk Management Regulation Increase Financial Stability?

This dissertation examines how bank risk management impacts financial stability. In the first chapter, my coauthors and I study how bank risk management impacts systemic risk using a global sample of banks from 2002 to 2020. We find that bank risk management has improved since the global financial crisis, driven by the implementation of country-level reforms mandating Chief Risk Officers and board-level risk committees. We find that stronger risk management lowers banks’ contribution to systemic risk. Using the staggered enactment of bank risk management reforms as a quasi-natural experiment, we provide evidence that the relation is causal. Subsample analysis on most impacted banks, defined as those without Chief Risk Officers or risk committees pre-reform, exhibit the largest reductions in systemic risk post-reform. We further document that banks with stronger risk controls have lower stand-alone risk, more stable funding, and higher valuations, suggesting that these are likely channels through which systemic risk is mitigated.

In the second chapter, I examine the impact of risk management on the performance of publicly traded U.S. banks during the Silicon Valley Bank crisis. Using a novel dataset of risk management characteristics that measure both the presence and strength of Chief Risk Officers and board-level risk committees, I find no evidence of a link between bank risk management and performance during the crisis. Tests on bank behavior before the crisis show that banks with stronger risk management hold larger amounts of interest rate derivatives for hedging purposes. However, this does not translate into better performance or lower uninsured deposit outflows during the crisis. Examining risk management within a subsample of banks with the greatest exposure to interest rate and deposit outflow risk confirms these results.

Together, these results indicate that the impact of risk management on financial stability depends on the situation. In normal economic times, strong risk management improves financial stability by lowering systemic and standalone risk. However, in times of acute banking stress, such as during the Silicon Valley Bank crisis, the benefits of stronger risk management are unclear. These findings suggest that while banks are not simply checking the box regarding risk management, current practices are not a blanket solution to financial stability.