Impact of Risk-Related Disclosure on the Risk-Taking Behavior of Commercial Banks in Pakistan

Abstract

Information asymmetry leads to moral hazard in commercial banks, as evidenced in the 2008 crisis. This study aims at analyzing the implications of risk disclosure practices of commercial banks on their risk-taking behavior in Pakistan. It also attempts at assessing the level of compliance for commercial banks with the specifications of Basel accord II under Pillar 3. For measuring disclosure level, a risk disclosure index is devised. The dependent variable i.e. risk-taking behavior is operationalized through portfolio risk. The analysis employed panel data techniques of Ordinary Least Squares (OLS). The relationship of risk disclosure index with risk-taking behavior, as expected, is found to be significantly negative; in line with information asymmetry and moral hazard hypotheses. These discoveries are consistent with the essence of market discipline that greater disclosure enables stockholders to more closely monitor and scrutinize, resulting in contrived and sensible risk taking. The results of the study provide evidence on the current state of market discipline and the vital part it plays in the risk-taking behavior of Pakistani commercial bank. This study is also significant for the regulators, and financial managers, that need adequate information for making informed decisions. As the results empirically confirm the issue of non-disclosures with an intent to take higher risks, in commercial banks of Pakistan. In the light of this study, the policy makers can strengthen regulations that govern risk disclosure practices, in order to uphold market discipline, realizing the ultimate objective of State Bank of Pakistan and Basel Committee for Banking Supervision

Keywords

• Risk Disclosures
• Basel Accord II
• Risk Taking Behavior
• Disclosure Index
• Moral Hazard
• Market Discipline