Policymakers require banks to maintain sufficient capital to ensure their stability. However, they largely ignore who provides that capital, which could also shape bank risk-taking. Understanding how the ownership structure of banks influences their behaviour could enhance financial regulation and supervision, ultimately making the financial system more resilient.

The supervisory and regulatory rules banks need to comply with have changed dramatically over the last twenty years. Recent turmoil in financial markets, however, shows that banks are not necessarily safer these days. Are these new regulations and supervisory tools missing some important factors? What would help to improve the stability of the banking system?

The financial crisis of 2008 – 2009 and the subsequent economic slowdown put bankers’ actions in the crosshairs of the public. Policymakers reacted and overhauled existing regulation, introducing new supervisory powers and expanding the set of capital and liquidity regulations.

These updated rules were intended to improve bank’s balance sheets and help them better weather a potential future financial crisis. Narratives of the Great Financial Crisis (GFC), however, argue that weak corporate governance measures also played an important role in the severity of the financial crisis. Researchers produced a bulk of empirical evidence examining how different aspects of bank governance shape bank stability. Aside from executive compensation and board structure, researchers now also have a better understanding of shareholders’ role in shaping bank risk, and shareholders play an important role in bank stability. First, they provide banks with high quality capital in the form of common stock that serves as a hard capital buffer against potential losses. Second, they control banks, as they are owners and thus set banks’ courses of action. When evaluating the impact of shareholders on bank behaviour, researchers typically distinguish between “insider” and “outsider” shareholders. “Insiders” are shareholders that have a relationship with the bank beyond their investment, for instance, because they are also executive officers or directors of a bank. “Outsiders”, on the other hand, do not have any relationship with the bank except their investment. While all shareholders vote on a bank’s course of action and thus control a bank, “insiders” are thought to also enjoy “private” benefits of control. For instance, an “insider” may benefit from more favourable loan rates when applying for credit. This may give rise to a conflict of interest for “insiders”: to ensure their private benefits, “insiders” may have little incentive to dilute their ownership stake by issuing new common stock. This may be especially problematic in times of crisis when the issuance of common stock may be particularly important in strengthening a bank’s capital level.

In our paper, we collect novel data on the ownership structure of large US banks and find that banks with a larger share of “insider” ownership issue less common stock in the aftermath of the GFC. The effect is also quite large and we show that the gap in bank’s dependence on common stock between high and low insider ownership banks grows by almost a quarter in the aftermath of the financial crisis. To provide further evidence, we separately examine banks where “insiders” are thought to enjoy larger private benefits of control. Specifically, we consider banks where (a) “insiders” have larger loans, or banks that are (b) relatively more opaque to provide greater benefits of control to “insiders”. We find that the effect is especially strong for these banks and our results are consistent with the idea that insiders’ dilution reluctance hampers the build-up of hard capital via the issuance of common stock.