Government Guarantees and Bank Risk Taking Incentives

Fischer, Markus; Hainz, Christa; Rocholl, Jörg; Steffen, Sascha

doi:10.2139/ssrn.1786923

Cited by 26 publications

(33 citation statements)

References 37 publications

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“…In addition, a recent strand of empirical literature deals with the eect of the removal of an implicit government guarantee on risk-taking, i.e., particularly the removal of the guarantee on deposits and other liabilities of German Landesbanken by the federal states in 2001. Gropp et al (2013), e.g., show that banks aected by the removal decrease borrower risk in new loans after 2001, while Fischer et al (2012) nd that aected banks increase their risk-taking in new loans in the transitions period after 2001 and before the removal becomes eective, consistent with theories on gambling.…”

supporting

confidence: 61%

“…For example, theories of gambling could explain a reverse eect as the Volcker Rule was predicted to not become eective for years to come. Compare, e.g., Fischer et al (2012); Hellmann et al (2000) for gambling evoked by regulatory changes that only become eective in the long run. We do not claim to provide a denitive interpretation here, but rather leave this to future research.…”

mentioning

confidence: 99%

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Wishful Thinking or Effective Threat? Tightening Bank Resolution Regimes and Bank Risk-Taking

Ignatowski,

Korte

2013

SSRN Journal

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may AbstractWe propose a framework for testing the eects of changes in bank resolution regimes on bank behavior. By exploiting the dierential relevance of recent changes in U.S. bank resolution (i.e., the introduction of the Orderly Liquidation Authority, OLA) for dierent types of banks, we are able to simulate a quasi-natural experiment using a dierence-in-dierence framework. We nd that banks that are more aected by the introduction of the OLA (1) signicantly decrease their overall risk-taking and (2) shift their business model and loan origination towards lower risk, indicating the general eectiveness of the regime change. This eect, however, does (3) not hold for the largest and most systemically important banks. Hence, the introduction of the OLA in the U.S. alone does not appear to have solved the too-big-to-fail problem and might need to be complemented with other measures to limit nancial institutions' risk-taking. Non-technical summary Bank regulators and legislators have discussed and brought into force signicant changes to bank resolution regimes in an eort to prevent future crises. However, can this really induce more prudent bank behavior? Economic theory indeed suggests that credible improvements in resolution regimes can increase overall bank discipline. When bank regulators, i.e., the authorities competent for resolution decisions, do not have access to a special bank resolution regime and appropriate resolution funds, they might incur large liquidity costs -such as temporary disruptions in lending that would add downward risks to the real economy -if they have to resolve a failed bank. Despite the long run benets of discipline, competent authorities might hence prefer bailouts or forbearance over straightforward resolution. Improvements in resolution regimes, however, that (a) legally empower the authorities to execute bank resolution faster and more eciently while preserving more liquidity, and (b) endow the authorities with sucient nancial resources to resolve banks, make resolution a more likely choice. Consequently, to the extent that an improvement in bank resolution regimes is credible and enforceable, implicit bailout guarantees might cease, and banks might change their behavior towards less risk-taking.Building on this theoretical background, we dene our hypothesis that banks aected by a tightening in resolution regimes alter their behavior towards less risk-taking and safer business models.We t...

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supporting

confidence: 61%

mentioning

confidence: 99%

Wishful Thinking or Effective Threat? Tightening Bank Resolution Regimes and Bank Risk-Taking

Ignatowski,

Korte

2013

SSRN Journal

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show abstract

“…In addition, a recent strand of empirical literature deals with the e ect of the removal of an implicit government guarantee on risk-taking, i.e., particularly the removal of the guarantee on deposits and other liabilities of German Landesbanken by the federal states in 2001. Gropp et al (2013), e.g., show that banks a ected by the removal decrease borrower risk in new loans after 2001, while Fischer et al (2012) nd that a ected banks increase their risk-taking in new loans in the transitions period after 2001 and before the removal becomes e ective, consistent with theories on gambling.…”

supporting

confidence: 58%

“…For example, theories of gambling could explain a reverse e ect as the Volcker Rule was predicted to not become e ective for years to come. Compare, e.g., Fischer et al (2012); Hellmann et al (2000) for gambling evoked by regulatory changes that only become e ective in the long run. We do not claim to provide a de nitive interpretation here, but rather leave this to future research.…”

Section: Testing For Alternative Explanationsmentioning

confidence: 99%

Wishful thinking or effective threat? Tightening bank resolution regimes and bank risk-taking

Ignatowski

Korte

2014

Journal of Financial Stability

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may AbstractWe propose a framework for testing the e ects of changes in bank resolution regimes on bank behavior. By exploiting the di erential relevance of recent changes in U.S. bank resolution (i.e., the introduction of the Orderly Liquidation Authority, OLA) for di erent types of banks, we are able to simulate a quasi-natural experiment using a di erence-in-di erence framework. We nd that banks that are more a ected by the introduction of the OLA (1) signi cantly decrease their overall risk-taking and (2) shift their business model and loan origination towards lower risk, indicating the general e ectiveness of the regime change. This e ect, however, does (3) not hold for the largest and most systemically important banks. Hence, the introduction of the OLA in the U.S. alone does not appear to have solved the too-big-to-fail problem and might need to be complemented with other measures to limit nancial institutions' risk-taking. Non-technical summary Bank regulators and legislators have discussed and brought into force signi cant changes to bank resolution regimes in an e ort to prevent future crises. However, can this really induce more prudent bank behavior? Economic theory indeed suggests that credible improvements in resolution regimes can increase overall bank discipline. When bank regulators, i.e., the authorities competent for resolution decisions, do not have access to a special bank resolution regime and appropriate resolution funds, they might incur large liquidity costs -such as temporary disruptions in lending that would add downward risks to the real economy -if they have to resolve a failed bank. Despite the long run bene ts of discipline, competent authorities might hence prefer bailouts or forbearance over straightforward resolution. Improvements in resolution regimes, however, that (a) legally empower the authorities to execute bank resolution faster and more e ciently while preserving more liquidity, and (b) endow the authorities with su cient nancial resources to resolve banks, make resolution a more likely choice. Consequently, to the extent that an improvement in bank resolution regimes is credible and enforceable, implicit bailout guarantees might cease, and banks might change their behavior towards less risk-taking.Building on this theoretical background, we de ne our hypothesis that banks a ected by a tightening in resolution regimes alter their behavior towards less risk-taking and safer busi...

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“…Kacperczyk and 8 Schnabl (2013) analyze the investment behavior of US MMF and find that these funds invested in riskier securities searching for yield as money inflow was responsive to fund yields. Fischer et al (2012) focus on the investment behavior of German Landesbanken and document a searching for yield due to risk shifting incentives after the announcement that government guarantees will be revoked. We show in our paper that yield chasing by European banks implies investing in high yielding long-term government debt financed with low yielding short-term wholesale funds which ultimately leaves the banks exposed to risky assets and high funding risk.…”

Section: Introductionmentioning

confidence: 99%

The "Greatest" Carry Trade Ever? Understanding Eurozone Bank Risks

Acharya

Steffen

2013

Self Cite

105

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This paper argues that the European banking crisis can in part be explained by a "carry trade" behavior of banks. Factor loading estimates from multifactor models relating equity returns to GIPSI (Greece, Ireland, Portugal, Spain and Italy) and German government bond returns suggest that banks have been long peripheral sovereign bonds funded in short-term wholesale markets, a position that generated "carry" until the GIPSI bond returns deteriorated significantly inflicting significant losses on banks. We show that the positive GIPSI factor loadings reflect actual portfolio holdings of GIPSI bonds in the cross-section of banks; and, the negative German loading reflects funding risk (flight away from bank funding to German government bonds), a risk that is increasing in the US money market mutual fund exposures of European banks as well as various proxies for bank short-term debt. Large banks and banks with low Tier 1 ratios and high risk-weighted assets had particularly large exposures and even increased their exposures between the two European stress tests of March and December 2010 taking advantage of a widening of yield spreads in the sovereign bond market. Over time, there is an increase in "home bias" -greater exposure of domestic banks to its sovereign's bonds -which is partly explained by the European Central Bank funding of these positions. On balance, our results are supportive of moral hazard in the form of risk-taking by under-capitalized banks to exploit low risk weights and central-bank funding of risky government bond positions.

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Government Guarantees and Bank Risk Taking Incentives

Cited by 26 publications

References 37 publications

Wishful Thinking or Effective Threat? Tightening Bank Resolution Regimes and Bank Risk-Taking

Wishful Thinking or Effective Threat? Tightening Bank Resolution Regimes and Bank Risk-Taking

Wishful thinking or effective threat? Tightening bank resolution regimes and bank risk-taking

The "Greatest" Carry Trade Ever? Understanding Eurozone Bank Risks

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