Taxation and bank risk-taking

A recent line of research views that tax deductibility of interest which creates a preference for debt over equity financing is often a trigger for greater risk-taking by banks, potentially threatening financial stability. This paper conducts an empirical assessment of the relationship between taxation and risk taking using an international sample of 15384 commercial bank-year observations, covering 96 countries over the period 2000-2011. The empirical results suggest that higher corporate income tax on banks has a significantly positive impact on bank risk but this is generally mitigated by more stringent regulatory measures associated with capital requirements, restrictions on bank activities and official supervisory power. On the other hand, higher degree of market discipline has a direct effect in reducing bank risk.