Does Risk Committee Matter? Evidence from the US Financial Institutions

Sebastian J. Widodo

March 2013

Abstract:

• In July 2010, the US government passed the Dodd-Frank Act which requires US banks with $10 billion or more in total assets to establish a standalone risk committee on board level. The Federal Reserve further requires these banks to appoint a CRO. This paper aims to analyze the potential usefulness of risk committee and CRO in light of these new requirements. 
• Using hand collected data from 310 US banks from 2007-2011, we find evidence that (1) the presence of a standalone risk committee is associated with lower risk taking activities in banks. Furthermore, we find evidence that (2) specific risk committee and corporate governance characteristics are associated with lower risk taking. 
• However, our findings suggest that (3) the presence of a CRO does not reduce risk taking.
• Moreover, our findings highlight a potential shortcoming of the Act since we find that (4) risk committee is only associated with lower risk taking for banks with less than $10 billion in total assets.

Discussions:

We shall kick start this blog with an unpublished honor thesis written by none other than yours truly. Significant findings have been highlighted in the abstract. Perhaps the greatest pain in writing this paper is in the data collection since the author need to hand collect the data from thousands of DEF 14A forms. Nonetheless, the findings are worth the efforts as we believe that this is the first paper that directly discusses the potential usefulness of the Dodd-Frank Act. 

Practical Implications:

Risk Committee (RC) may not be able to do much to manage risk, especially in the big banks, perhaps due to the complexity of their operations. So shall we just do away with this whole RC to save cost for shareholders? and should banks just sack their CROs? These are tricky questions considering the high degree of public scrutiny towards the FIs in the recent years. Do governments/regulators create tones of regulations just to show the public that at least  they try to do something without actually considering the usefulness of the regulations?