Abstract

This study examines whether bank shareholders, especially those of riskier banks, bear part of the cost of the Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 in U.S. banking industry. Since riskier banks are imposed on tighter and heavier regulatory oversight and charged higher costs after FDICIA, FDICIA may be expected to have different effects on expected profit or return for the banks with different risk positions. This presumably will lead to an increased negative effect on the shareholders of riskier banks. Consistent with these premises, we found over the period 1988-1994 that the positive associations between the banks' risk measures estimated from the well-known two factor return generating model and stock return appeared to become weaker after FDICIA. This result suggests that bank share-holders may not be compensated for taking risks as much as they were before FDICIA system, therefore bearing at least part of the cost of FDICIA. Based on the test for the partitioned sample, we found that the shareholders of the riskier banks (the banks with higher ratio of non-performing loans) bear more of the cost of FDICIA.