Financial market discipline on bank risk: Implications of state ownership

Abstract

This study investigates the link between capital market discipline and bank-level credit risk with a special emphasis on the role of bank ownership structure. Focusing on a large emerging market, Türkiye, characterized by a prominent state bank presence, our baseline regression results indicate that banks' stock price volatility elevates in response to the increases in non-performing loan ratio for the period 2008–2021. More importantly, the extent of capital market discipline on credit risk is amplified for state-owned banks. This finding remains similar against a myriad of robustness checks. To analyze the implications on alternative financial markets, we further extract high-frequency implied volatility measures from options contracts recently traded on individual bank stocks. By utilizing the Covid-19 outbreak as an exogenous shock to local banks’ loan portfolio quality, we perform difference-in-differences estimations for the interval of October 2019–June 2020. Our findings show that the implied volatility for non-private banks increases more in the post-shock phase compared to other bank ownership types.