What Can Bank Supervisors Learn from Equity Markets?

Abstract

Much recent academic attention has focused on the relative ability of markets and bank supervisors to assess the risk of depository institutions. We add to that literature by comparing the factors influencing bank holding company risk, as gauged by equity markets, with the factors influencing the confidential BOPEC scores, as awarded by bank supervisors. Specifically, we regress stock market measures of holding company risk and BOPEC scores on a host of on- and off-balance sheet risk measures taken from the Federal Reserve's Consolidated Financial Statements for Bank Holding Companies (FR Y-9C reports). Our sample includes data from 1988 through 1993. We estimate regressions year by year on a sample of 98 holding companies, with yearly observations ranging from 69 to 79. The results suggest that both equity markets and regulators closely scrutinize credit risk. Beyond that, the results suggest that regulators pay close attention to capital strength. Taken together, the evidence supports the view that the stock market emphasizes risk-return trade-offs, whereas regulators care more about probability of failure.