Will New Banking Practices Create Possible Convergence between Regulators and Banks' Interest?

Abstract

The fierce competition in the banking industry compels banks to take more risks in order to maximize their profit. Since the introduction of regulation into the banking industry, banks have considered that whatever its type, regulation represents an obstacle to their main objective, namely profit-maximization. Therefore, banks never cease seeking to evade regulations, for example by using financial innovations. The subprime crisis has shown that banks' attitude and conduct in response to regulations do really amply the impact of the crisis. As a result, regulatory reforms are necessary. Most of the solutions proposed focus on regulators' interest and behavior. Nevertheless, few of them try to reconcile regulators' interest with bank's interest by taking into account banks' consideration that the banking regulation is inconsistent with their profit-maximization objective. Indeed, the implementation of risky strategies has a two-edged effect, a positive effect allowing profit-maximization and a negative effect causing losses, both of them are amplified by the interdependence between banking strategies due to the increased dependence of banking activities on financial markets. Therefore, this empirical paper is aimed at finding the risky strategies of which negative effect is more significant and which are not in line with the bank's objective. By using the neural network method, we present empirical evidence for the fact that a joint risky liquidity and leverage strategies, which are widely used in the banking industry have a disastrous impact on the bank's performance. Accordingly, the future regulation combined of liquidity and leverage regulation can reconcile the interest of banks and regulators.