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Implications of the Previous Theoretical Discussion for This Book 135
bank for the risk’s contribution to its total risk costs. 27 This logic should
even hold when the risk is uncorrelated with factors that are priced in the
capital markets, that is, for diversifiable or specific risk.
Returning to Figure 4.1, it is worthwhile to emphasize that a bank’s
capital structure should be determined by the bank’s exposure to total risk
(i.e., to both systematic and specific risk) and driven by its concern with
creditworthiness. Even though some of the post-modern models realize how
critical financial policy/structure can be in enabling companies to make
valuable investments, 28 none of these models includes the role of risk management
in accepting value-enhancing projects. Additionally, while the current
practice in risk management seems to aim mostly at specific risk, it
became clear in the above discussion that risk management should also aim
at systematic risk and hence the totality of risk. 29
Eighth, the market imperfections introduced in the neoinstitutional section
seem to indicate that firm (stakeholder) value maximization might be
a better corporate objective for banks than shareholder value maximization,
since the costs entailed in shareholder value maximization might have adverse
effects on all (bank) stakeholders. 30
The differences between the two theories can be summarized as shown
in Table 4.1.
We can, therefore, deduce the following implications for the further
structure of this book:
■
■
First, we need to define and derive an adequate total risk measure
for banks, because (especially in a non-normal world) neither systematic
nor specific risk capture the concern with lower-tail outcomes
well. We also need to discuss the interrelation of such a risk measure
with the capital structure of banks, both of which we will do in
Chapter 5.
Second, we need to define an adequate capital-budgeting tool that
reflects the interrelation of capital budgeting, capital structure, and
risk management, and that provides a consistent merger of the two
theories, that is, encompasses market as well as bank internal portfolio
considerations. We will, therefore, investigate in Chapter 6
27 The only way to control the firm’s risk exposure to nonmarketable risks is by
investing less aggressively in illiquid risk.
28 According to Myers (1977) and Myers and Majluf (1984), firms face real tradeoffs
in how they finance their investments.
29 See Chapter 2 for a more detailed discussion of this issue in a banking context.
30 This is especially true for banks, since they care about total risks for good reasons.
As shown previously, “bank runs” induce a state in which all of the business is lost
immediately (which is relevant for all stakeholders) and, in general, bank stakeholders
are extremely credit sensitive and cannot diversify that risk.