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Bank Transparency and the Market’s Perception of Bank Risk

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Abstract

We investigate the effect of bank transparency on systematic and idiosyncratic risk in the stock market. Using the extent of individual banks’ timely recognition of expected loan losses and the amount of discretionary loan loss provisions as proxies for bank transparency, we find that more transparent banks are associated with lower idiosyncratic, and total, stock market risk. We also find that banks that use more discretionary loan loss provisions are associated with a lower ratio of systematic to idiosyncratic risk. In addition, the effect of bank transparency on stock market risk is mainly observed during the financial crisis period. Our results are robust to alternative transparency measures, the possibility of a non-linear relationship, and application of a dimensionality reduction procedure, and offer empirical evidence that providing more bank-specific information about loan portfolio risk mitigates uncertainty about a bank’s future events.

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Notes

  1. Available at http://www.ny.frb.org/research/banking_research/datasets.html.

  2. Available at http://www.nber.org/cycles/cyclesmain.html.

  3. For example, Kanagaretnam et al. (2010) argue that negative discretionary LLP reflect a greater incentive to increase reported earnings under the earnings management hypothesis.

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Authors and Affiliations

  1. School of Economics, University of Seoul, 163 Seoulsiripdae-ro, Dongdaemun-gu, Seoul, 02504, South Korea

    Jinyong Kim

  2. School of Management Engineering, KAIST College of Business, 85 Hoegiro, Dongdaemun-gu, Seoul, 02455, South Korea

    Mingook Kim

  3. Securities-Derivatives R&D Center, Korea Exchange, 76 Yeouinaru-ro, Yeongdeungpo-gu, Seoul, 07329, South Korea

    Yongsik Kim

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  1. Jinyong Kim
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  2. Mingook Kim
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  3. Yongsik Kim
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Correspondence to Jinyong Kim.

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Kim, J., Kim, M. & Kim, Y. Bank Transparency and the Market’s Perception of Bank Risk. J Financ Serv Res 58, 115–142 (2020). https://doi.org/10.1007/s10693-019-00323-7

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