The Strategic Underreporting of Bank Risk

Taylor A. Begley, Amiyatosh Purnanandam, Kuncheng Zheng

Research output: Contribution to journalArticlepeer-review

34 Scopus citations

Abstract

We show that banks significantly underreport the risk in their trading book when they have lower equity capital. Specifically, a decrease in a bank's equity capital results in substantially more violations of its self-reported risk levels in the following quarter. Underreporting is especially frequent during the critical periods of high systemic risk and for banks with larger trading operations. We exploit a discontinuity in the expected benefit of underreporting present in Basel regulations to provide further support for a causal link between capitalsaving incentives and underreporting. Overall, we show that banks' self-reported risk measures become least informative precisely when they matter the most.

Original languageEnglish
Pages (from-to)3376-3415
Number of pages40
JournalReview of Financial Studies
Volume30
Issue number10
DOIs
StatePublished - Oct 1 2017

Bibliographical note

Funding Information:
We are grateful to Sean Campbell, Jean Colliard, Rainer Haselmann, Vasso Ioannidou, Mauricio Larrain, Gregor Matvos, Uday Rajan, Philipp Schnabl, Sergio Vicente and seminar participants at the Bank of England, Banque de France, Dutch Central Bank, Federal Reserve Bank of New York, London Business School, Notre Dame, University of Houston, University of Miami, University of Michigan, Michigan State University, Purdue University, Surrey, Washington University in St. Louis, Wayne State University, and Wharton and conference participants at AFA (San Francisco), Baffi-Carefin (Bocconi), Barcelona GSE Summer Forum, Lancaster Corporate Finance Conference, NBER Summer Institute, Texas Finance Festival, Tel-Aviv Finance Conference, and the WFA (Seattle) for helpful comments on the paper. Purnanandam gratefully acknowledges financial support from Smith Richardson Foundation for this research. Supplementary data can be found on The Review of Financial Studies web site. Please send correspondence to Taylor Begley, Washington University in St. Louis, CB 1133, One Brookings Drive, St. Louis, MO 63130; telephone: (314) 935-6329. E-mail: tbegley@wustl.edu.

Publisher Copyright:
© 2017 The Author. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved.

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

Cite this