Working Paper: CEPR ID: DP10311
Authors: Mike Mariathasan; Ouarda Merrouche; Charlotte Werger
Abstract: The recent crisis has shown that banks in distress can often expect to benefit from (implicit) government guarantees. This paper analyzes a panel of 781 banks from 90 countries to test whether the expectation of individual and systemic government support induces moral hazard. It shows that banks tend to be more leveraged, funded with capital of lower quality, more heavily invested in risky assets and exposed to more severe liquidity mismatch when they themselves -but also when their competitors- are perceived as being more likely to benefit from government support. We show that the default of Lehman Brothers in 2008 reduced moral hazard in the short-run, but not in the long-run, as the systemic consequences of Lehman?s failure became apparent. In addition, our large country coverage allows us to provide new results on policies, institutions, and regulations that can be put in place to reduce moral hazard induced by implicit guarantees to the banking sector.
Keywords: bailout; banking; government guarantees; moral hazard
JEL Codes: G20; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Lehman Brothers' default in 2008 (G33) | banks' risk-taking reassessment (G21) |
| lower FSRs (G21) | higher expectations of government support (H53) |
| Fitch Support Ratings (FSR) (G24) | banks' leverage (G21) |
| Fitch Support Ratings (FSR) (G24) | banks' capital quality (G21) |
| Fitch Support Ratings (FSR) (G24) | banks' liquidity mismatch (G21) |
| expectations of government support (H53) | banks' risk-taking behaviors (G21) |