Supervisory Effectiveness and Bank Risk*

Abstract

This paper investigates the role of banking supervision in controlling bank risk. Banking supervision is measured in terms of enforcement outputs (i.e., on-site audits and sanctions).Our results show an inverted U-shaped relationship between on-site audits and bank risk, while the relationship between sanctions and risk appears to be linear and negative. We also consider the combined effect of effective supervision and banking regulation (in the form of capital and market discipline requirements) on bank risk. We find that effective supervision and market discipline requirements are important and complementary mechanisms in reducing bank fragility. This is in contrast to capital requirements, which prove to be rather futile in controlling bank risk, even when supplemented with a higher volume of on-site audits and sanctions.JEL Classifications: G21; G32; G38

Bank Regulation, the Quality of Institutions, and Banking Risk in Emerging and Developing Countries: An Empirical Analysis

“…This result confirms the view that restrictions on bank activities do not necessarily reduce financial fragility (cf. In contrast, Delis and Staikouras (2011) find that the distance to default is reduced by regulation limiting bank activities. Beck et al (2006) even report that activity restrictions increase the likelihood of a banking crisis by limiting the opportunities to diversify risk.…”

“…An increase of 1 percent of our aggregate measure of bank regulation and supervision decreases banking risk by 0. In contrast, Beck et al (2006) and Delis and Staikouras (2011) do not find evidence that capital regulations reduce the fragility of the banking system as measured by the occurrence of a banking crisis or the distance to default. In columns 3-9, we therefore add these measures subsequently to the baseline specification.…”

“…Delis and Staikouras 2011;Demirgüç-Kunt and Detragiache 1998;Kaminsky and Reinhart 1999;Klomp and de Haan 2012). Delis and Staikouras 2011;Demirgüç-Kunt and Detragiache 1998;Kaminsky and Reinhart 1999;Klomp and de Haan 2012).…”

Financial Fragility of Banks In Vietnam: The Role of Revenue Diversification and National Governance Quality

“…Specifically, Barth, Caprio Jr and Levine [54] emphasize the importance of regulations and supervisory practices on mitigating risks while improving performance and stability of the banking sector. Delis and Staikouras [55] learn that bank risks have a U-shaped relationship with supervision and a negatively linear correlation with sanctions. The authors, therefore, suggest that an effective combination between supervision and market discipline requirements can decrease the probability of banks" failure.…”

The Effect of Bank Supervision on Risk Taking: Evidence from a Natural Experiment

“…Delis and Staikouras (2011) conduct a cross-country study in which they relate the frequency of on-site examinations and sanctions to bank-level risk taking, and find a generally negative association. Gopalan et al (2016) use the opening and closing of field offices to show that a bank's distance to its supervisor is positively related to leverage and probability of failure.…”