The interrelationships between bank risk and market discipline in Southeast Asia

Purpose The purpose of this study is to examine whether a bidirectional relationship between bank risk and market discipline may exist in Southeast Asia. Design/methodology/approach A simultaneous equations model with a three-stage least squares estimator is used to examine the interrelationships between bank risk and market discipline using a sample of 79 listed banks in five countries in Southeast Asia (ASEAN-5) from 2006 to 2019. Findings The findings show a two-way relationship between bank risk and market discipline. In particular, market discipline has a negative impact on bank risk, while there is a positive relationship between bank risk and market discipline. A bidirectional relationship between them still holds when using an alternative measure of bank risk in subsamples, controlling for the global financial crisis and governance indicators. Practical implications The findings indicate that market discipline can reduce bank risk. Meanwhile, a positive impact of bank risk on market discipline reemphasizes that market discipline is a powerful tool to ensure banks do not have excessive risk-taking. Nonetheless, the findings suggest that further implementation of market discipline as the third pillar of the Basel framework is necessary for the banking systems in ASEAN-5. Originality/value To the best of the authors’ knowledge, this study is the first attempt to investigate the interrelationship between bank risk and market discipline in Southeast Asia.