Time-Varying Systematic and Idiosyncratic Risk Exposures of US Bank Holding Companies

Abstract

We study the time-varying risk exposures of US bank holding companies for the 1986 to 2012 period by decomposing total bank risk into systematic banking-industry risk, systematic market-wide risk, and idiosyncratic bank risk. Banking-industry risk factors directly relate to the banks’ financial intermediation functions while market-wide risk factors affect all stocks. In contrast, idiosyncratic risk reflects individual bank risk characteristics. We analyze the systematic bank risk factors in time series regressions, determine their importance with a democratic orthogonalization technique, and explore the idiosyncratic risk in a panel regression framework. Our results suggest that corporate credit risk and real estate risk are most detrimental in crisis periods, while banks’ interest-rate-risk sensitivity changes over the last decade. The banks’ leverage, loan-loss provisions, fraction of real estate loans, and proportion of non-interest income relate to the differences in individual bank risk. Moreover, banks’ idiosyncratic risk contains a strong state-level business cycle component. Our results are robust to alternative risk factor specifications. Overall, our study contributes to understanding the structure and time-variation of banks’ systematic and idiosyncratic risks.