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Review of Financial Studies Vol. 30 No. 10 2017

The Strategic Underreporting of Bank Risk

Taylor A. Begley1; Amiyatosh Purnanandam2; Kuncheng Zheng3

1 London Business School and Olin Business School, Washington University in St. Louis · 2 Ross School of Business, University of Michigan · 3 D’Amore-McKim School of Business, Northeastern University

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 capital-saving incentives and underreporting. Overall, we show that banks’ self-reported risk measures become least informative precisely when they matter the most. Received April 30, 2015; editorial decision October, 27 2016 by Editor Itay Goldstein.

DOI
10.1093/rfs/hhx036
Volume
30
Issue
10
Pages
3376-3415
Language
en
Sources
openalex crossref

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