Risk-taking in banks: Does skin-in-the-game really matter?

Research output: Contribution to journalArticlepeer-review

Abstract

The belief that bank capital helps improve stability takes for granted the idea that increases in capital are an incentive to reduce risk-taking because bank owners would have more to lose (skin-in-the-game) if their banks fail. Nevertheless, given the higher cost of capital as compared to debt, it is also possible that increases in capital would lead to higher risk-taking due to the need for banks to boost their returns. In light of these contradictory possibilities, we exploit exogenous variations of capital to empirically investigate the actual effects of capital on risk-taking. Our analyses based on a sample of nearly 1,900 US Banking Holding Companies in the 1990-2020 period indicate that increasing capital actually leads to higher risk-taking, which contradicts the skin-in-the-game hypothesis. We show evidence that this relationship could be explained by the consequent increase in funding costs that creates pressure for better returns, which is normally achieved by means of taking higher risk. Our main findings are robust to a number of alternative model and sample specifications.
Original languageEnglish
Pages (from-to)404-424
Number of pages21
JournalJournal of Banking Regulation
Volume25
Issue number4
Early online date9 Mar 2024
DOIs
Publication statusPublished - Dec 2024

Keywords / Materials (for Non-textual outputs)

  • bank capital
  • risk-taking
  • skin-in-the-game
  • funding costs

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