How the Market Judges Bank Risk
Elijah Brewer III , Cheng Few Lee
The risks that a bank faces can be judged by looking at such accounting data as asset composition, quality, and liquidity; capital adequacy; and earnings. Financial theory suggests that the risk sensitivity of a bank can also be judged by examining the returns required by financial markets-specifically the market for bank equities. Using both accounting and market data, we compare the financial characteristics of bank holding companies from different parts of the country. We find that there is a significant but imperfect correlation between accounting-based measures of equity risk and market-based measures of equity risk. We also find that there are regional differences in the market response. For example, the equities of New York City bank holding companies exhibit more sensitivity to certain kinds of risk than do Chicago, California, or regional bank holding companies. Finally, we find that regional differences in branching laws have an important impact on bank equity risk through their effect on a bank's reliance on purchased funds.
