This study investigates the effects of bank safety-oriented cultures on loan contracts. We regress stock returns during the 1998 Long-Term Capital Management (LTCM) crisis on these risk-taking characteristics and obtain a residual component to proxy the safety-oriented culture of banks. Our empirical results show that banks with a safety-oriented culture increase the probability of signing a contract with low risk borrowers and that they charge lower loan spreads. We also find that these banks ask for more loan covenants to protect their creditor’s rights. Finally, banks with a safety-oriented culture suffer less from borrowers’ defaults and have higher market responses around the dates of loan announcements. Also, our findings reject the alternative hypothesis that banks with a safety-oriented culture only accept less risky lending due to their conservative risk attitude, thus destroying market value for banks.

The focus of this paper is whether the Securities and Exchange Commission's Regulation SHO strengthens or weakens the effect of short-selling threats on banks’ risk-taking. The evidence shows that pilot banks with looser constraints on short-selling increased their risk-taking during the financial crisis of 2007–2009. The reason is that short-selling threats improved the information environment and mitigated the agency problems of banks during the pilot program that led to greater risk-taking by pilot banks. Additionally, this effect is mainly driven by pilot banks with poor corporate governance, or high information asymmetry. Overall, our paper provides novel evidence that the disciplinary role of short-sellers had a positive effect on bank risk-taking during the financial crisis.