The relationship between excessive lending, risk premium and risk‐taking: Evidence from European banks

Abstract

Banks normally trade-off the amount of loans created by the amount of risk piled up in their assets portfolios. However, their performance can induce a 'search for yield' or 'gamble to survive' behaviour. Using sample of 149 European banks during the period 2001-2016, we show that the risk management hypothesis holds for the period after the 2007-2008 financial crisis and for large banks. Contrarily, the moral hazard hypothesis, under which banks practise excessive lending to relatively risky borrowers that pay higher premium but increase their credit risk, is supported in the pre-crisis period and for small banks. Additionally, we provide important implications to suggest that the post-crisis regulations have restrained banks with poor performance from the 'gamble to survive' behaviour.

Determinants of Differentiation of Cost of Risk (CoR) among Polish Banks during COVID-19 Pandemic

“…Banks' performance is affected by a "search for yield" (risk management hypothesis) or "gamble to survive" policy. Alhalabi et al (2021) provided important implications suggesting that in the case of large banks the risk management hypothesis was proved for the period preceding the subprime crisis. At the same time, the moral hazard behaviour related to excessive lending to risky borrowers who pay higher premiums thus substantially increasing credit risk was observed before the Global Financial Crisis, although it referred only to small banks.…”