Stand-alone vs systemic risk-taking of financial institutions

Purpose - This study investigates the risk-taking behavior of financial institutions in the USA. Specifically, differences between taking risks that affect primarily the shareholders of the institution and risks contributing to the overall systemic risk of the financial sector are examined. Additionally, differences between risk-taking before, during and after the financial crisis of 2007/2008 are examined. Design/methodology/approach - To analyze the determinants of stand-alone and systemic risk, a generalized linear model including size, governance, charter value, business cycle, competition and control variables is estimated. Furthermore, Granger causality tests are conducted. Findings - The results show that systemic risk has a positive effect on valuation and that corporate governance has no significant effect on risk-taking. The influence of competition is conditional on the state of the economy and the risk measure used. Systemic risk Granger-causes idiosyncratic risk but not vice versa. Research limitations/implications - The major limitations of this study are related to the analyzed subset of large financial institutions and important risk-culture variables being omitted. Practical implications - The broad policy implication of this paper is that systemic risk cannot be lowered by market discipline due to the moral hazard problem. Therefore, regulatory measures are necessary to ensure that individual financial institutions are not endangering the financial system. Originality/value - This study contributes to the empirical literature on bank risk-taking in several ways. First, the characteristics of systemic risk and idiosyncratic risk are jointly analyzed. Second, the direction of causality of these two risk measures is examined. Moreover, this paper contributes to the discussion of the effect of competition on risk-taking.