Risk governance: Impact of the risk committee and Chief Risk Officer on banks’ risk and performance

Abstract

This study empirically examines the effects of Risk Committee (RC) characteristics and Chief Risk Officer (CRO) attributes on the risk and performance of U.S. commercial banks, specifically from the period 2016-2019. Using a sample of 241 banks with 966 bank-year observations, the research investigates the relationships between RC and CRO characteristics and three distinct types of risk - credit, regulatory, and insolvency – and two performance measures: Return on Equity (ROE) and Return on Assets (ROA). This study explores the impact of Risk Committees (RCs) and Chief Risk Officers (CROs) in the context of U.S. commercial banks' risk management and performance. The analysis shows that RC existence correlates significantly with a reduction in credit risk, possibly due to heightened attention towards managing this crucial risk factor. However, RC presence doesn't markedly affect regulatory or insolvency risks, nor does it significantly impact key performance metrics such as Return on Equity (ROE) and Return on Assets (ROA). RC size positively associates with credit risk, suggesting that larger RCs might have greater confidence in managing and controlling such risks. Still, no significant relationship is found with other risks or performance measures. Interestingly, RC independence doesn't significantly influence any risk or performance measures. This study reveals a positive correlation between the qualifications of Risk Committee (RC) members in finance and accounting and the acceptance of higher credit risk by banks. This implies that well-qualified RC members, armed with their depth of knowledge and experience, might enable the bank to navigate and manage higher levels of risk more confidently. However, the study finds no significant association between RC qualifications and regulatory risk, insolvency risk, and the bank's performance, possibly due to various factors not captured fully by the study models. Moreover, the study establishes a significant positive relationship between the frequency of RC meetings and credit risk, suggesting that more active RCs (those holding frequent meetings) tend to take on more credit risk. This behaviour might reflect greater confidence due to their active involvement in risk management. However, a significant negative relationship was observed between the number of RC meetings and regulatory risk, implying that active RCs could help mitigate regulatory risk. The study found no significant impact of RC meetings on the bank's performance. The research also considers specific attributes of the CRO. It reveals that the presence of a CRO in an organization shows no significant association with credit, regulatory, and insolvency risks, but it does have a significant association with performance. This suggests that while the mere presence of a CRO may not directly impact the management of various risks, it does correlate negatively with organizational performance. This could indicate that CROs reduce senior managers ability to take risky decision with higher returns. The power of the CRO shows a positive and significant association with credit and regulatory risks but no significant association with insolvency risk and performance. This implies that CROs with greater authority or influence are better able to manage credit and comply with regulations, highlighting the importance of their role in these specific areas. However, their power doesn't seem to translate effectively into managing the risk of insolvency or enhancing overall performance. Interestingly, CRO qualifications do not show a significant association with any of the risks or performance metrics considered. This might suggest that formal qualifications or specific educational backgrounds are not the primary drivers of effectiveness in the CRO role. Instead, other factors like experience, organizational support, or the specific context of the organization might play more critical roles. CRO tenure shows a mixed impact. There is a negative and significant association with both credit and regulatory risks, but no significant association with insolvency risk. However, it positively correlates with performance. This complexity may reflect the learning curve and growing influence of a CRO over time, where extended tenure helps in refining organizational strategies for better performance, though it might not necessarily reduce certain types of risks. The gender of the CRO, specifically being a female CRO, is significantly associated with insolvency risk but not with credit risk, regulatory risk, or performance. This singular significant association could indicate that gender might play a role in specific risk management areas, like insolvency risk, though the underlying reasons for this require further investigation. These research findings could have profound implications for standards-setters and regulators in various ways. Given the evidence that the existence of a Risk Committee (RC) reduces credit risk, and a Chief Risk Officer (CRO) tenure correlates negatively with bank’s credit risk, regulators may want to further enforce the establishment of these mechanisms in banks. They may also consider guidelines on the ideal size of an RC, and the specific qualifications desirable for RC members. The findings highlight the value of gender diversity in risk management, as female CROs seem to manage insolvency risk better. This could prompt regulators to advocate for more diverse gender representation in executive roles, especially within risk management. The study's indication that CROs with longer tenures manage risk more effectively could lead to regulatory encouragement for continuity in risk management leadership roles, thereby reducing frequent changes in these positions. The research findings could also have thoughtful implications for banks in general and U.S. commercial banks specifically in many ways. The findings clearly underscore the importance of having a Risk Committee (RC) in managing credit risk. Banks might consider forming an RC voluntarily. Banks may also assess the size of their RCs, given that larger RCs appear to accommodate greater credit risk. The research indicates that more qualified RCs are associated with a proactive approach to risk management that leads to an acceptance of higher credit risk. Therefore, banks may want to ensure that their RCs are highly qualified and capable of managing and accepting higher credit risks. The findings highlight the positive impact of a Chief Risk Officer (CRO) tenure on bank performance. Furthermore, the positive correlation between CRO tenure and risk management suggests that banks should strive to retain their CROs for longer periods. The research indicates that banks with female CROs demonstrate lower insolvency risk. Banks might want to consider this while making hiring decisions for the CRO and other high-ranking risk management positions. Finally, the study found that CROs with finance or accounting qualifications show no impact on bank’s risk or performance. This insight can be beneficial when recruiting for the CRO position or for offering further education opportunities to current CROs. Investors are key stakeholders who are likely to benefit from the findings of this research. The existence of a Risk Committee (RC) and a Chief Risk Officer (CRO) tenure are associated with lower risk and better bank performance, respectively. Investors might take these factors into account when assessing the governance of banks in which they consider investing. Investors can understand the risk profile of a bank better by considering the characteristics of its RC and CRO. For instance, larger RCs accommodate greater credit risk, and RCs with more qualifications accept higher credit risk. In addition, longer-tenured CROs seem to manage credit and regulatory risks more effectively. Investors can use these findings to evaluate the performance of a bank. The finding that several relationships, such as RC independence and risk measures, show insignificance might make investors more aware of bank's practices and underlying risk factors. The findings indicate that banks with female CROs exhibit lower insolvency risk and superior performance. This could lead investors to appreciate gender diversity in leadership roles as a factor contributing to a bank's performance and risk profile. The research findings enhance the rare literature regarding risk governance in banks. It underscores the significance of an RC's existence in the reduction of credit risk, arguably the most consequential risk faced by commercial banks. However, the non-impact on regulatory or insolvency risks and performance metrics challenges prevailing assumptions about RCs' universal risk mitigation and performance enhancement role. This encourages further investigation into the efficacy of RCs in managing different types of risks and advancing performance. The positive correlation between RC size and credit risk opens a new dialogue on risk acceptance and risk management capabilities of larger committees. Moreover, the absence of a significant relationship between RC independence and risk or performance measures presents an opportunity for further academic exploration, focusing on the interaction between RC autonomy and its impact on a bank's risk and performance landscape. The study also reveals a fascinating connection between the qualifications of RC members and their acceptance of credit risk, suggesting a higher risk appetite in banks managed by highly qualified committees. The implications of this finding are substantial for academia, calling for additional research to elucidate the complexities around qualifications, risk appetite, and risk management. The study's focus on the role of CROs brings new insights into the gender dynamics in risk management. The finding that banks with female CROs tend to have lower levels of insolvency risk stimulates further discussion about gender diversity in leadership roles and its impact on risk management. It also points towards the possibility of distinct risk management strategies adopted by male and female CROs. The study's focus on specific CRO attributes - presence, power, qualifications, tenure, and gender - and their relationships with risk and performance outcomes significantly enhances the understanding of the CRO's role. Particularly, the findings about CRO tenure having a negative relationship with credit and regulatory risks and a positive association with bank performance highlight the value of experience and continuity in this critical role. Overall, this study enriches risk governance literature by bringing attention to the multifaceted roles of RCs and CROs. It emphasizes the need for a differentiated approach to managing various risk types and offers valuable insights for improving risk governance practices within commercial banks. Its findings provide an impetus for further research, focusing on the interplay of various RC and CRO attributes and their impact on risk management and bank performance.