Measuring the risk appetite of bank-controlling shareholders: The Risk-Weighted Ownership index

Abstract

This study proposes a measure of the risk appetite of a bank's ownership structure and investigates whether ownership risk propensity is related to performance and default risk. Our indicator, the Risk-Weighted Ownership (RWO), assumes that credit risk is a proxy for shareholders' risk appetite and assigns risk weights based on the Basel standard approach to the stakes held by the top 5, 10, and 20 controlling shareholders. We calculate the RWO index using a sample of 76 listed banks from the Eurozone and the United Kingdom from 2008 to 2017. The RWO correlates with bank fundamentals when we regress it with accounting- and market-based performance and risk measures. We present two major findings. First, the RWO index incorporates the risk appetite of controlling shareholders, and its variance is affected by the ownership structure. Second, a higher risk appetite among shareholders is associated with higher profitability but lower bank capitalization, implying a trade-off between performance and default risk. Overall, we find that the risk appetite of the ownership structure is an important driver of bank performance and risk.