How Does Regulation Affect the Risk Taking of Banks? A U.S. and Canadian Perspective

Abstract

This historical study utilizes annual insured bank data from 1936 through 1989 to empirically evaluate the impact of bank regulation on bank risk taking in a cross-country comparison of the United States and Canada. Risk is hypothesized to be determined, in part, by the regulatory environment in which a bank operates. The findings of this analysis contributes to the contemporary deregulation policy debate, since both branch banking restrictions and deposit insurance variables are found to be detrimental to bank stability. More specifically, these results support the 1994 Riegle–Neal Interstate Banking and Branching Efficiency Act, which removed legislative barriers to interstate branching. These results also confirm expectations that deposit insurance increases risk taking and supports the 1991 mandate by regulators that risk-based deposit insurance be created. Further, these findings support the 1988 Basel Accord to standardize bank capital requirements internationally and to link these standards to bank risk taking.