IDEAS home Printed from https://ideas.repec.org/p/ecb/ecbwps/20101272.html
   My bibliography  Save this paper

The impact of public guarantees on bank risk taking: evidence from a natural experiment

Author

Listed:
  • Gropp, Reint
  • Gruendl, Christian
  • Guettler, Andre

Abstract

In 2001, government guarantees for savings banks in Germany were removed following a law suit. We use this natural experiment to examine the effect of government guarantees on bank risk taking, using a large data set of matched bank/borrower information. The results suggest that banks whose government guarantee was removed reduced credit risk by cutting off the riskiest borrowers from credit. At the same time, the banks also increased interest rates on their remaining borrowers. The effects are economically large: the Z-Score of average borrowers increased by 7.5% and the average loan size declined by 17.2%. Remaining borrowers paid 46 basis points higher interest rates, despite their higher quality. Using a difference-in-differences approach we show that the effect is larger for banks that ex ante benefited more from the guarantee and that none of these effects are present in a control group of German banks to whom the guarantee was not applicable. Furthermore, savings banks adjusted their liabilities away from risk-sensitive debt instruments after the removal of the guarantee, while we do not observe this for the control group. We also document in an event study that yield spreads of savings banks’ bonds increased significantly right after the announcement of the decision to remove guarantees, while the yield spread of a sample of bonds issued by the control group remained unchanged. The results suggest that public guarantees may be associated with substantial moral hazard effects. JEL Classification: G21, G28, G32

Suggested Citation

  • Gropp, Reint & Gruendl, Christian & Guettler, Andre, 2010. "The impact of public guarantees on bank risk taking: evidence from a natural experiment," Working Paper Series 1272, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20101272
    Note: 56868
    as

    Download full text from publisher

    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecbwp1272.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Sironi, Andrea, 2003. "Testing for Market Discipline in the European Banking Industry: Evidence from Subordinated Debt Issues," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(3), pages 443-472, June.
    2. Sapienza, Paola, 2004. "The effects of government ownership on bank lending," Journal of Financial Economics, Elsevier, vol. 72(2), pages 357-384, May.
    3. Gropp, Reint & Vesala, Jukka & Vulpes, Giuseppe, 2006. "Equity and Bond Market Signals as Leading Indicators of Bank Fragility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 399-428, March.
    4. Armen Hovakimian & Edward J. Kane, 2000. "Effectiveness of Capital Regulation at U.S. Commercial Banks, 1985 to 1994," Journal of Finance, American Finance Association, vol. 55(1), pages 451-468, February.
    5. Gianni De Nicolo & Elena Loukoianova, 2007. "Bank ownership, market structure, and risk," Proceedings 1058, Federal Reserve Bank of Chicago.
    6. Berger, Allen N. & Miller, Nathan H. & Petersen, Mitchell A. & Rajan, Raghuram G. & Stein, Jeremy C., 2005. "Does function follow organizational form? Evidence from the lending practices of large and small banks," Journal of Financial Economics, Elsevier, vol. 76(2), pages 237-269, May.
    7. John H. Boyd & Mark Gertler, 1994. "The role of large banks in the recent U.S. banking crisis," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 18(Win), pages 2-21.
    8. Astrid A. Dick, 2006. "Nationwide Branching and Its Impact on Market Structure, Quality, and Bank Performance," The Journal of Business, University of Chicago Press, vol. 79(2), pages 567-592, March.
    9. Puri, Manju & Rocholl, Jörg & Steffen, Sascha, 2011. "Global retail lending in the aftermath of the US financial crisis: Distinguishing between supply and demand effects," Journal of Financial Economics, Elsevier, vol. 100(3), pages 556-578, June.
    10. Demirguc-Kunt, Asli & Detragiache, Enrica, 2002. "Does deposit insurance increase banking system stability? An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 49(7), pages 1373-1406, October.
    11. Viral V. Acharya & Iftekhar Hasan & Anthony Saunders, 2006. "Should Banks Be Diversified? Evidence from Individual Bank Loan Portfolios," The Journal of Business, University of Chicago Press, vol. 79(3), pages 1355-1412, May.
    12. Vasso Ioannidou & Steven Ongena & José-Luis Peydró, 2015. "Monetary Policy, Risk-Taking, and Pricing: Evidence from a Quasi-Natural Experiment," Review of Finance, European Finance Association, vol. 19(1), pages 95-144.
    13. Merton, Robert C., 1977. "An analytic derivation of the cost of deposit insurance and loan guarantees An application of modern option pricing theory," Journal of Banking & Finance, Elsevier, vol. 1(1), pages 3-11, June.
    14. Cordella, Tito & Yeyati, Eduardo Levy, 2003. "Bank bailouts: moral hazard vs. value effect," Journal of Financial Intermediation, Elsevier, vol. 12(4), pages 300-330, October.
    15. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December.
    16. John H. Boyd & Gianni De Nicoló, 2005. "The Theory of Bank Risk Taking and Competition Revisited," Journal of Finance, American Finance Association, vol. 60(3), pages 1329-1343, June.
    17. Berger, Allen N. & Mester, Loretta J., 1997. "Inside the black box: What explains differences in the efficiencies of financial institutions?," Journal of Banking & Finance, Elsevier, vol. 21(7), pages 895-947, July.
    18. Barth, James R. & Caprio, Gerard Jr. & Levine, Ross, 2004. "Bank regulation and supervision: what works best?," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 205-248, April.
    19. Jeremy C. Stein, 2002. "Information Production and Capital Allocation: Decentralized versus Hierarchical Firms," Journal of Finance, American Finance Association, vol. 57(5), pages 1891-1921, October.
    20. Martin R. Goetz, 2012. "Bank diversification, market structure and bank risk taking: theory and evidence from U.S. commercial banks," Supervisory Research and Analysis Working Papers QAU12-2, Federal Reserve Bank of Boston.
    21. Reint Gropp & Hendrik Hakenes & Isabel Schnabel, 2011. "Competition, Risk-shifting, and Public Bail-out Policies," The Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 2084-2120.
    22. Boyd, John H. & Runkle, David E., 1993. "Size and performance of banking firms : Testing the predictions of theory," Journal of Monetary Economics, Elsevier, vol. 31(1), pages 47-67, February.
    23. Edward I. Altman, 1968. "Financial Ratios, Discriminant Analysis And The Prediction Of Corporate Bankruptcy," Journal of Finance, American Finance Association, vol. 23(4), pages 589-609, September.
    24. Beck, Thorsten & Demirguc-Kunt, Asli & Levine, Ross, 2006. "Bank concentration, competition, and crises: First results," Journal of Banking & Finance, Elsevier, vol. 30(5), pages 1581-1603, May.
    25. Flannery, Mark J, 1998. "Using Market Information in Prudential Bank Supervision: A Review of the U.S. Empirical Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 273-305, August.
    26. Demsetz, Rebecca S & Strahan, Philip E, 1997. "Diversification, Size, and Risk at Bank Holding Companies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 300-313, August.
    27. Froot, Kenneth A., 1989. "Consistent Covariance Matrix Estimation with Cross-Sectional Dependence and Heteroskedasticity in Financial Data," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(3), pages 333-355, September.
    28. Martin Ruckes, 2004. "Bank Competition and Credit Standards," The Review of Financial Studies, Society for Financial Studies, vol. 17(4), pages 1073-1102.
    29. Emilia Bonaccorsi Di Patti & Giorgio Gobbi, 2007. "Winners or Losers? The Effects of Banking Consolidation on Corporate Borrowers," Journal of Finance, American Finance Association, vol. 62(2), pages 669-695, April.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Morten Balling & Peter Egger & Ernest Gnan & Axel A. Weber & Harald W. Stieber & Stavros Vourloumis & António Afonso & João Tovar Jalles & Franco Bruni & André van Poeck & Maartje Wijffelaars & Séveri, 2013. "States, Banks, and the Financing of the Economy: Fiscal Policy and Sovereign Risk Perspectives," SUERF Studies, SUERF - The European Money and Finance Forum, number 2013/2 edited by Morten Balling & Peter Egger & Ernest Gnan, May.
    2. Gropp, R. & Grundl, C. & Guttler, A., 2012. "Does Discretion in Lending Increase Bank Risk? Borrower Self-Selection and Loan Officer Capture Effects," Other publications TiSEM bfec5360-2a2b-47e4-ba3f-d, Tilburg University, School of Economics and Management.
    3. Reint Gropp & Hendrik Hakenes & Isabel Schnabel, 2011. "Competition, Risk-shifting, and Public Bail-out Policies," The Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 2084-2120.
    4. Gropp, Reint & Guettler, Andre, 2018. "Hidden gems and borrowers with dirty little secrets: Investment in soft information, borrower self-selection and competition," Journal of Banking & Finance, Elsevier, vol. 87(C), pages 26-39.
    5. Evren Damar & Reint Gropp & Adi Mordel, 2013. "The Ex Ante versus Ex Post Effect of Public Guarantees," World Scientific Book Chapters, in: Douglas D Evanoff & Cornelia Holthausen & George G Kaufman & Manfred Kremer (ed.), The Role of Central Banks in Financial Stability How Has It Changed?, chapter 18, pages 347-364, World Scientific Publishing Co. Pte. Ltd..
    6. Randall Kroszner, 2016. "A Review of Bank Funding Cost Differentials," Journal of Financial Services Research, Springer;Western Finance Association, vol. 49(2), pages 151-174, June.
    7. Hrychiewicz, Aneta, 2012. "Government Interventions - Restoring or Destructing Financial Stability in the Long-Run?," Working Papers 12-02, University of Pennsylvania, Wharton School, Weiss Center.
    8. Hryckiewicz, Aneta, 2014. "What do we know about the impact of government interventions in the banking sector? An assessment of various bailout programs on bank behavior," Journal of Banking & Finance, Elsevier, vol. 46(C), pages 246-265.
    9. Schnabel, Isabel & Körner, Tobias, 2012. "Abolishing Public Guarantees in the Absence of Market Discipline," VfS Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 65401, Verein für Socialpolitik / German Economic Association.
    10. Brei, Michael & Jacolin, Luc & Noah, Alphonse, 2020. "Credit risk and bank competition in Sub-Saharan Africa," Emerging Markets Review, Elsevier, vol. 44(C).
    11. Hakenes, Hendrik & Schnabel, Isabel, 2010. "Banks without parachutes: Competitive effects of government bail-out policies," Journal of Financial Stability, Elsevier, vol. 6(3), pages 156-168, September.
    12. Chen, Minghua & Wu, Ji & Jeon, Bang Nam & Wang, Rui, 2017. "Do foreign banks take more risk? Evidence from emerging economies," Journal of Banking & Finance, Elsevier, vol. 82(C), pages 20-39.
    13. Brandao-Marques, L. & Correa, R. & Sapriza, H., 2012. "International Evidence on Government Support and Risk-Taking in the Banking Sector," Other publications TiSEM 4a9756af-eb63-4867-ae29-3, Tilburg University, School of Economics and Management.
    14. repec:zbw:bofrdp:2011_007 is not listed on IDEAS
    15. Beck, Thorsten, 2008. "Bank competition and financial stability : friends or foes ?," Policy Research Working Paper Series 4656, The World Bank.
    16. Bruno Martins & Ricardo Schechtman, 2013. "Too Rich to Let Me Fail?," Documentos de Investigación - Research Papers 13, CEMLA.
    17. Fang, Yiwei & Hasan, Iftekhar & Marton, Katherin, 2011. "Market reforms, legal changes and bank risk-taking : evidence from transition economies," Research Discussion Papers 7/2011, Bank of Finland.
    18. Goetz, Martin R. & Laeven, Luc & Levine, Ross, 2016. "Does the geographic expansion of banks reduce risk?," Journal of Financial Economics, Elsevier, vol. 120(2), pages 346-362.
    19. Lammertjan Dam & Michael Koetter, 2011. "Bank bailouts, interventions, and moral hazard," Proceedings 1131, Federal Reserve Bank of Chicago.
    20. Berger, Philip G. & Minnis, Michael & Sutherland, Andrew, 2017. "Commercial lending concentration and bank expertise: Evidence from borrower financial statements," Journal of Accounting and Economics, Elsevier, vol. 64(2), pages 253-277.
    21. Francesco Marchionne & Alberto Zazzaro, 2018. "Risk and competitiveness in the Italian banking sector," Economics Bulletin, AccessEcon, vol. 38(1), pages 271-280.

    More about this item

    Keywords

    banking; credit risk; market discipline; moral hazard; public guarantees;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ecb:ecbwps:20101272. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Official Publications (email available below). General contact details of provider: https://edirc.repec.org/data/emieude.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.