Using data on publicly traded banks in 61 countries, we examine how the institutional environment affects the relationship between bank capital and system-wide fragility. Consistent with prior studies, we find that bank capital is associated with a reduction in the systemic risk contribution of individual banks. This effect is more pronounced for banks located in countries with less efficient public and private monitoring of financial institutions and in countries with lower levels of information availability. Overall, our findings suggest that capital can act as a substitute for a weak institutional environment in reducing systemic risk.

We find that shareholder-friendly corporate governance is associated with higher stand-alone and systemic risk in the banking sector. Specifically, shareholder-friendly corporate governance results in higher risk for larger banks and for banks that are located in countries with generous financial safety nets as banks try to shift risk toward taxpayers. We confirm our findings by comparing banks to nonfinancial firms and examining changes in bank risk around an exogenous regulatory change in governance. Our results underline the importance of the financial safety net and too-big-to-fail guarantees in thinking about corporate governance reforms at banks.