Market-to-Book, Charter Value, and Bank Risk-Taking – A Recent Perspective - April 2005

This paper studies the determinants of bank charter value and its disciplining effect on bank risktaking in the period since the mid-1980s. Due to significant macro developments in the banking industry, including legislation and regulation, consolidation, and technological advances, we find the magnitude, determinants, and the disciplining effect of bank charter value changed quite substantially over time. Our evidence indicates that bank size and operating efficiency were two main drivers in determining bank charter values. Banking firms seemed to have earned rents from their non-interest revenues, though the impact may have faded in recent years. Charter values of banking organizations did not appear to be systematically related to traditional loans and deposits, except savings and small time deposits. The disciplining effect of charter value on bank risk-taking was robust and significant during the earlier periods when the average charter value was low, and became weaker more recently despite a substantial increase in average charter values. The diminishing disciplining effect is consistent with the substantial increase in bank capitalization since the early 1990s, and the proliferation of capital market discipline bought about by supervision and regulation that realigned bank risk-taking with banking firms’ cost of capital.