Market-based indicators of homogeneity and risk taking in the banking sector

We evaluate the impact of post-crisis regulations on homogeneity and risk taking in the banking sector through market-based indicators. In the past decade, many regulatory reforms have been implemented or are gradually being phased in. Higher capital requirements and stricter rules should make individual banks safer. However, safer individual banks do not necessarily imply a safer banking sector. If banks respond in a homogenous fashion to new regulations it may decrease the stability of the sector as a whole. Our analysis shows that there are indeed indications of such an increased homogeneity. Bank stock returns have become substantially more correlated over time. Furthermore, market indicators of risk based on bank equity and bank option prices also signal vulnerabilities. Regulation may be a factor of importance as it imposes restrictions that can yield a similar response by banks, for example with respect to their choice of activities, balance sheet structure, and risk management. We argue that market-based indicators provide forward-looking information about homogeneity and risk taking in the banking sector. This information is relevant for investors, analysts and regulators for making investment decisions and identifying new vulnerabilities in the financial system.