Risk Management pays

This has just come out. www.nber.org/papers/w16178


Ellul, A. and V. Yerramilli (2010). Stronger risk controls, lower risk: Evidence from US Bank holding companies. Cambridge, MA, NBER.

In this paper, we investigate whether US bank holding companies (BHCs) with strong and independent risk management functions have lower enterprise-wide risk. We hand-collect information on the organisational structure of the risk management function at the 74 largest publicly-listed BHCs and use this information to construct a Risk Management Index (RMI) that measures the strength of organisational risk controls. We find that BHCs with a high RMI in the year 2006 had lower exposure to private label mortgage backed securities, were less active in trading off-balance sheet derivatives, had a smaller fraction of non-performing loans and had lower downside risk during the crisis years. In a panel spanning the 9 year period 2000-08, we find that BHCs with higher RMIs have lower enterpise wide risk, after controlling for size, profitability, a variety of risk characteristics, corporate governance, CEO's pay-performance sensitivity and BHC fixed effects. This result holds even after controlling for any dynamic endogeneity between risk and internal risk controls. Overall, these results suggest that strong internal risk controls are effective in restraining risk-taking behaviour at banking institutions.


The risk management index (RMI) measures presence of CRO, if CRO is among the 5 highest paid executives, and relative pay CRO vs CEO. The RMI also considers composition of the board’s Risk Committee (whether there is significant banking experience??), frequency of meetings of risk committee.

Also finds that stock market rewards banks with higher RMI."