Regulations, Bailouts and Bank Shareholders’ Wealth: An International Analysis

Abstract

This paper examines the effectiveness of worldwide banking regulations and supervisions in providing a balanced risk-reward trade-off to bank shareholders. Our comprehensive global analysis of 2,467 banks across the world identifies the regulatory frameworks that are associated with favorable risk-return profile trade-off during normal growth as well as financial crisis periods. Ownership structure and restrictions on types of business activities both stand out as the most effective regulatory mechanisms as they increase return and reduce risk. Auditing and disclosures are good regulations and enhance stock valuations in growth periods but ironically these measures bring problems to light more quickly in crisis environment and result in greater stock holder losses. Entry restrictions or blanket depositor insurance mechanisms are the worst forms of regulation from stock investor perspective because they lower return in growth periods and increase risk in the crisis periods. German legal origins and mandatory provisioning regulations signify conservative policies as they lower the return in times of growth but also lower the risk in crisis periods. Finally, we investigate whether recent regulatory interventions could effectively curtail bank shareholder wealth loss. We infer based on our findings that direct capital injection by government, or tax breaks did not boost stock valuations as much as government guarantees, infrastructure spending and initiatives to buy toxic assets did.