Essays on bank risk management

Congyu Liu

doi:10.17918/a30q-je40

This dissertation includes three chapters. The first chapter studies the impact of compensation on the types of risk taken by bank CEOs according to the time horizon when losses are realized. Bonus is recognized to encourage executives to boost short-term profits while equity compensation motivates long term growth. I use Guidance on Sound Incentive Compensation Policies ("the Guidance"), part of the Dodd-Frank Act, as an exogenous shock to the compensation structure of executives in banks with over $1 billion total assets. The Guidance requires banks to make deferred payment and risk adjusted awards. Using banks with less than $1 billion in assets as control, I find that the treated banks pay executives with higher percentage in the stocks and engage in activities with less short-term risk and less down-side long-term risk. This paper empirically documents the effectiveness of the Guidance on the bank CEOs compensation and show that the compensation structure alters the types of risk that CEOs take. This second chapter documents the cross hedging of interest rate risk within bank holding companies (BHCs): Subsidiaries capable of risk management manage interest rate risk for themselves and for other banks in the same BHC. Bank mergers are used as exogenous shocks to address endogeneity concerns. Cross hedging increases with the complexity of BHCs, uses funds from the external capital market, and reduces exposure to interest rate risk. The paper contributes to the internal capital market literature by documenting risk management redistribution in BHCs. The third chapter examines the relation between deposit market power and several interest rate risk management tools, including interest rate derivatives hedging, wholesale funding management, and liquid asset management. Drechsler et al. (2017) document that banks can transmit monetary policy without interest rate risk because of their deposit market power. This paper hypothesizes that other risk management tools can be substitutions for market power. It finds that banks with larger market power have lower derivatives hedging level. They respond to a Fed fund rate increase with higher wholesale funding and liquid asset holding to replace the deposit outflow. This paper contributes to the banking risk management literature by documenting the mutual relation among risk management tools.

Essays on bank risk management

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Essays on bank risk management

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