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Legal Protection, Idiosyncratic Shock and Bank Risk

ZHU Xiao-wu;MO Yang-dong;Business School, China University of Political Science and Law;  
Legal protection and bank risk are hot issues, which have aroused extensive academic and practical concern. But the relation between legal protection and bank risk remains an open question. Using a unique sample of 121 Chinese banks for from 2007 to 2014, it sets up the Banking Granular Residual of idiosyncratic shocks by 5 large banks and examines the relation between legal protection and bank risk. Then it analyses the impact of idiosyncratic shocks by large banks to small and medium banks. At last it studies whether legal protection can moderate the relation between idiosyncratic shocks of large banks and small and medium banks risk. This paper shows that legal protection and bank risk have a U-curve relation. There exists a law protection level of minimum bank risk. The positive idiosyncratic shocks at large banks can reduce the risk of small and medium banks. Legal protection moderates the idiosyncratic shocks at large banks to the risk of small and medium banks. These findings have certain reference value to policy. Legal protection has an effect of "firewall" for bank risk. Bank risk may be a new indicator of legal protection.
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