Does Investor Protection Affect Bank Liquidity Risk

There has been a large literature on bank liquidity risk since the 2008 global financial crisis because liquidity risk was at the heart of the crisis. However, there is no study that investigates whether the level of investor protection influences liquidity risk-taking behavior of banks. Therefore, this study aims to explore the relationship between investor protection and liquidity risk as well as to provide policy implications. Using a panel dataset of commercial banks in 21 OECD countries, we found that strong investor protection encourages banks to take lower liquidity risk. Furthermore, this positive role of shareholder protection is more prominent during a crisis, implying that legal protection of investors plays an essential role in bank stability while market discipline is largely ineffective due to extensive government guarantees in turbulent times. ■ keyword :∣Financial Institutions∣Liquidity Risk∣Investor Protection∣Financial Crisis∣Law and Finance∣ 접수일자 : 2019년 07월 10일 수정일자 : 2019년 08월 19일 심사완료일 : 2019년 08월 26일 교신저자 : 김정심, e-mail : jskim@sangji.ac. kr 투자자 보호제도가 은행들의 유동성위험에 영향을 미치는가? 243 banking system and economic growth. Ivashina and Scharfstein (2010) argued that banks with higher liquidity risk, relying more heavily on short-term debt, reduced their lending more during the crisis. The supply of credit is crucial for the growth of the economy. Ippolito et al. (2019) reported that banks with greater liquidity risk offer tougher conditions to borrowers who violate their covenant of credit lines, forcing them to change their source of finance. Kim (2018) and Jiang et al. (2019) showed that competition leads banks to reduce their liquidity risk, contributing to financial stability. Despite a large body of literature on bank liquidity risk, most studies have focused mainly on from the perspective of credit supply and market structure. Not much attention has been paid to the relationship between investor protection and liquidity risk-taking behavior of banks. In fact, the last crisis also shed new light on investor expropriation by bank managers and controlling shareholders, such as enormous executive perquisites, personal loans to insiders, and excessive compensation, taking advantage of risk-shifting[8][9]. The limited research in this area is surprising given the severity of the crisis which stemmed from excessive liquidity risk. Therefore, this paper attempts to fill this gap by investigating whether minority shareholder protection leads banks to take on less liquidity risk, considering the impact of the 2008 financial crisis. Why should we focus on shareholders when it comes to liquidity risk-taking behavior of banks? That is because the last financial crisis raised questions about the effectiveness of market discipline, which had long been recognized as a key mechanism to keep the banking system stable. Previous literature argued that market participants—such as institutional investors and other short-term creditors—have an ability and incentives to punish banks for taking excessive risk because they have to bear losses from bank failures. In line with this argument, many studies showed that market discipline performs well in normal times, whereas it might not be effective due to substantial government guarantees during times of market stress[10-12]. The discipline in the marketplace, however, was largely absent around the last financial crisis. In such circumstances, shareholders could be a complementary source to impose discipline on bank management in that their investments are directly associated with bank performance. If the legal system can effectively support shareholders to exercise their rights, then they may perform well as a monitor of bank liquidity risk-taking. Using a panel dataset for 11,640 bank-year observations of 21 Organization for Economic Cooperation and Development (OECD) countries from 2000 to 2014, we found that investor protection contributes to lower bank liquidity risk. Interestingly, this beneficial role of investor protection becomes more pronounced during a crisis, suggesting that better shareholder protection encourages banks to curb liquidity risk-shifting in times of market stress. This paper contributes to the literature as follows. First, this paper is the first study to show that the legal protection for shareholders plays a vital role in managing liquidity risk. Given the significance of managing liquidity risk for bank stability, it is important to understand how legal and institutional systems affect liquidity risk-taking of banks. Second, 한국콘텐츠학회논문지 '19 Vol. 19 No. 9 244 this paper provides important policy implications on the necessity of strong investor protection for the stability of the banking system. That is, the legal system for shareholders matters for liquidity risk-taking behavior of banks. Furthermore, this legal factor becomes more meaningful during a crisis in which market discipline by non-deposit creditors does not work well in turbulent times while dominant insiders’ risk-shifting incentives significantly increase due to extensive government supports such as bank bailouts. II. Literature Review and Hypothesis