Bank dividends, risk, and regulatory regimes

This paper investigates the relation between bank dividends and bank risk over the period 1984-2011, and assesses the existence of risk-taking and risk-shifting in the US commercial banking sector subject to regulatory regime changes. The introduction of PCA in 1992 and TARP in 2008 constitute significant regulatory regime changes, and provide the necessary framework to explore whether regime-dependent risk-shifting or risk-taking is present. We find strong evidence of risk-shifting and risk-taking over the post-PCA regime spanning the period 1992-2008. We interpret this evidence as indication of ineffectiveness of PCA in controlling risk-taking and risk-shifting. The finding of risk-taking just prior to the recent financial crisis suggests that risk-taking may be a factor contributing to this crisis. As risk-taking and risk-shifting are important aspects of bank behavior (Basel Committee on Banking Supervision, 2009), these results are of interest to bank regulators and important to Basel III.

► We examine the relation between bank dividends and bank risk. ► We assess risk-taking and risk-shifting subject to regulatory changes. ► We find evidence of risk-shifting and risk-taking over the post-PCA regime. ► We interpret this evidence as indication of ineffectiveness of PCA. ► Risk-taking may be a factor contributing to the recent crisis.