Audit quality, banks’ equity risk and cross-country regulations

The recent turmoil in global financial markets has accentuated the need to better understand the fundamental determinants of bank risks. A large body of literature has emerged to address this issue in depth. However, the role of auditing in monitoring and shaping bank risk taking has not hitherto been considered. In this paper we examine the link between audit quality, banks' equity risk and cross-market regulatory differences in the G10 countries in the run-up to the 2007-2009 financial crisis. We find that higher audit quality is, on average, associated with lower systematic risk and this link is stronger in countries with weaker regulations. Our empirical findings bear important strategic implications for bank regulators and supervisors with an interest in improving auditing standards and banking sector policies.