Dodd-Frank and risk-taking: reputation impact in banks

Ezelda Swanepoel,Ronnie Lotriet,Ja’Nel Esterhuysen,Gary Van Vuuren

doi:10.21511/bbs.12(1).2017.04

Abstract

The banking industry plays a significant role in both the financial system and economy as a whole. By 2012, the US banking system owned US $14.45 trillion in assets. However, the importance of the banking system stretches beyond its mere size. Numerous studies have indicated that the health of this sector has significant effects on overall economic activity, as well as the size and persistence of economic cycles. For the purposes of this paper, the researchers measured the correlation between current legislation, risk-taking, market value, and reputation. This was performed by calcula-ting Z-scores to determine bank risk-taking. The Z-scores were correlated to market value to determine its impact. Reputable firm behavior was used to determine the correlation between market value and reputation. The statistical package for Social Sciences was used to perform ANOVA analysis of share value and Z-scores. A literature review was conducted to determine the reputational impact. It was determined that current legislation might have a desired result on risk-taking, that risk-taking might not have an impact on market value, and that reputation might have an impact on market value. Keywords: reputation, banking industry, financial system, economic activity, Z-scores, legislation, risk-taking. JEL Classification: C21, G18, G21, G32, G38, K23

Highlights

The United States (US) economy expanded rapidly since the last financial downturn in 1920, with the inflationary assistance of bankers and the federal government
It was determined that current legislation might have a desired result on risk-taking, that risk-taking might not have an impact on market value, and that reputation might have an impact on market value
Two timelines were used in order to accurately predict the impact that new legislation might have on the risk-taking, and on the market value of the banks

Summary

Introduction

The United States (US) economy expanded rapidly since the last financial downturn in 1920, with the inflationary assistance of bankers and the federal government. From 1929 to 1933, US Gross National Product (GNP) declined by 29%, the price level fell by 25%, the unemployment rate reached 25%, and approximately 9 000 banks suspended operations because of financial distress (Wheelock, 1995). As a result of the exceptional amount of speculation permitted by Wall Street rules, which many believe contributed largely to the economic downturn (Rothbard, 1972), the Glass Steagall Act was passed in 1933 (Lucas Jr & Nicolini, 2014). This Act prohibited National and Federal Reserve member banks and bank holding companies (BHCs) from underwriting corporate equity and debt (White, 2010). The Act was passed as a result of perceived conflicts of interest between banking and underwriting (Calomiris & Haber, 2013)

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