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Banks without Parachutes – Competitive Effects of Government Bail-out Policies

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  • Hendrik Hakenes

    ()
    (Max Planck Institute for Research on Collective Goods, Bonn, Germany)

  • Isabel Schnabel

    ()
    (Max Planck Institute for Research on Collective Goods, Bonn, Germany)

Abstract

The explicit or implicit protection of banks through government bail-out policies is a universal phenomenon. We analyze the competitive effects of such policies in two models with different degrees of transparency in the banking sector. Our main result is that the bail-out policy unambiguously leads to higher risk-taking at those banks that do not enjoy a bail-out guarantee. The reason is that the prospect of a bail-out induces the protected bank to expand, thereby intensifying competition in the deposit market and depressing other banks’ margins. In contrast, the effects on the protected bank’s risk-taking and on welfare depend on the transparency of the banking sector.

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Bibliographic Info

Paper provided by Max Planck Institute for Research on Collective Goods in its series Working Paper Series of the Max Planck Institute for Research on Collective Goods with number 2004_12.

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Length: 33 pages
Date of creation: Nov 2004
Date of revision:
Handle: RePEc:mpg:wpaper:2004_12

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Keywords: Government bail-out; banking competition; transparency; “too big to fail”; financial stability;

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References

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  1. Thoughts on the future of banking in Ireland…
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