Bank Internationalization and Risk-Taking

This paper investigates the effects of bank internationalization on risk-taking. We find that internationalization increases bank risk-taking: the Z-score of US banks that engage in foreign activities is lower than that of their purely domestic peers. The results are consistent with the empirical dominance of the market risk hypothesis, whereby internationalization increases banks’ risk due to market specific factors (competition, culture, regulatory complexity, economic and political instability, etc.) over the diversification hypothesis, whereby internationalization allows banks to reduce risk through increased diversification of their operations. The results continue to hold after conducting a variety of robustness tests, including accounting for endogeneity and sample selection bias. In additional tests, we find that risk-taking is more pronounced during financial crises due to a potentially higher impact of the market specific factors. These findings suggest that authorities might consider additional supervision or regulation of the activities of international banks. JEL Classification Codes: G21, G28, L25