Banks' complexity-risk nexus and the role of regulation

We investigate the relationship between bank complexity and bank risk-taking using German banking data over the period 2005-2017. We find that more complex banking organizations tend to take on more risk, but that this complexity-risk nexus decreases over time. We study how regulatory tightenings inherent in this period, and addressing systemically important banks (SIBs) in general and complexity more specifically, alter banks’ choices of complexity and risk. Banks reduce their complexity in response to regulatory tightenings, as these increase the related regulatory costs. Surprisingly, for SIBs in particular, the reduction of regulatory costs is associated with an increase in diversification benefits. As a result, they are able to lower their idiosyncratic risk more than other banks. The overall complexity-risk nexus is lower after regulatory tightenings. Thus, our results indicate that post-crisis regulation is effective in reducing banks’ complexity-risk nexus.