This thesis builds up on the scarce empirical academic literature that investigated the relationship between features related to risk management governance and banks’ financial performance which is limited to the works of Aebi et al. (2012); Battaglia and Gallo (2015); Ellul and Yerramilli (2013). In addition, this research is the first to explore the relationship between risk governance and financial stability regardless of the banks’ type. While the nexus between bank governance and risk-taking behaviour has been established by the theory (Fama and Jensen, 1983; Jensen and Meckling, 1976), the empirical explorations are richer when it comes to discussing the banks’ performance with features of corporate governance such as the role of the board of directors, the importance of the board committees and the CEO power through their remuneration schemes among others. Considering the critical importance of sound risk management decisions and their implementation to the soundness of the financial system and the prevention of a systemic risk, it is of a pressing need from the academia and the financial regulators to identify, explore ex-ante and continuously monitor ex-post the robustness of the risk management mechanisms that enable banks to achieve their essential role in the economy as financial intermediaries first and contribute to the growth of the real economy without compromising their individual stability and business objectives.
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In addition to filling this gap, this thesis contributes to the body of knowledge by exploring the link between risk governance and performance in a different geographical area that is the GCC region, hence building on the previous studies performed on banks in North America (Aebi et al., 2012), bank holding companies in the U.S (Ellul and Yerramilli, 2013) and Chinese and Indian markets (Battaglia and Gallo, 2015). A convergence is found between the results from these three first studies on risk management governance and ones of the present thesis. Specifically, for conventional banks in the GCC better risk governance structures are found to increase return on average assets and improve operational efficiency. In the North American market, Aebi et al. (2012) find that one proxy of sound risk governance that is the direct reporting line of the CRO to the BOD induces higher ROE and higher buy-and-hold stock returns. In the U.S market, Ellul and Yerramilli (2013) find that bank holding companies that display stronger risk management index (RMI) have higher returns on assets and lower tail risks. This study is the only one that tackles the relationship between risk management organizational frameworks and both financial performance and financial stability indicators. Hence, results from the empirical work in Chapter 4 also relate to the findings of Ellul and Yerramilli (2013). Lastly, in the Chinese and Indian markets, Battaglia and Gallo, (2015) find that the risk governance proxy of the size of risk committee is positively related to the returns on assets and the returns on equity.
Furthermore, the three essays that compose this thesis are the first to include Islamic banks in their empirical and comparative investigations on the subject of risk governance. While studies on corporate governance in Islamic banks exist, the exploration of the status of risk governance within their overall governance architectures has not been performed yet. The inclusion of Islamic banks in a comparative study with conventional counterparts operating in the same
region is motivated by (i) the need to probe whether the boundaries that are set out by Shari’ah
to monitor the risk-taking behaviour, through the presence of a Shari’ah Supervisory Board,
either in partnership investments or in consumer financing result in stronger and healthier risk management practices and whether these promote higher financial performance and enhanced
stability. Note that the compliance with Shari’ah and hence the presence of a Shari’ah
Supervisory Board is the main feature that distinguishes Islamic from conventional banking business models and that it is therefore what produces differences in the assets and liabilities structure and risk management of their balance sheets. As they follow Islamic moral principles, Islamic banks are also expected to widen the scope of their responsibility to encompass the observance of the interests of stakeholders and not only ones of the shareholders. These moral
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principles are reflected in the Islamic corporate governance through the principles that govern business ethics, the motivations for transparency and disclosures from a religious perspective as well the guidance on the process of elaboration of decision-making and the importance of accountability in Islam (Abu-Tapanjeh, 2009). The role of the SSB is also expected to substantiate the corporate governance frameworks in Islamic banks by these Islamic corporate governance norms. Nonetheless, results from the empirical work led in this thesis do not valid
these assumptions. Despite the importance of risk or the concept of gharar in Islamic financial
and commercial transactions for which the Shari’ah scholars that sit in the SSB are expected to
set the boundaries between the permissible and prohibited to allow Islamic banks to serve their communities and likewise generate profitability, it appears that their strategic organizational structures -which include the SSB- do not foster robust risk management mechanisms that can enable the achievement of these targets. In addition, the inclusion of Islamic banks in this thesis is also motivated by (ii) the need to explore whether the choice and establishment of sound risk management governance structures contributed to their higher stability as the study of Hasan and Dridi (2010) was first to demonstrate in the troubled times that followed the GFC. The results from Chapters 2 and 4 show that first risk governance structures in Islamic banks are weaker than the conventional counterparts that operate in the same jurisdictions and second that there is no association between their risk governance frameworks and the financial stability measures of insolvency likelihood, capital adequacy, asset quality and liquidity profile. It is important to note as well that the GCC region counts the highest number of Islamic financial institutions that experienced the largest asset growth in the decade between 2006 and 2016 (The Banker, 2016) and is one of the 14 jurisdictions where Islamic banks are considered as systemically important financial institutions. This further explains the rationale behind choosing the GCC as the geographical region for this empirical research.
From a theoretical perspective, the contributions of this thesis dwell in the exploration of the bank governance mechanisms that enable them to operate under the unique challenges of their position as financial intermediaries. Maturity transformation, liquidity risks and balance sheets opacity together pose a concern for the banks’ shareholders, depositors, debtholders and taxpayers at large (Becht et al., 2011). These concerns portray the implications on corporate governance and considering the post-crisis conjuncture the implications are essentially on the governance of risk management within the overall corporate governance frameworks and at the highest organizational levels. By using advanced econometric methods through the application of the two-step system generalized method of moments, the linkages between the governance
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of risk and financial performance on the one hand and the governance of risk and bank-level financial stability have been explored with various robustness tests. On the side of practice, the contributions of this research add to the previous empirical literature that has shown evidence for the positive effects that sound corporate and risk governance mechanisms can have on enhancing the performance of banking corporations and contribute to their individual level financial stability. These mechanisms pertain mainly to adequate size of the banks’ board of directors, higher degrees of its independence, higher degrees of independence of the audit and risk committees, frequent committee meetings, direct reporting lines of the CRO to the board and of the internal audit to the audit committee, enhanced awareness about the stature of the CRO and of the internal audit function among a few others.