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Risk-Shifting by Federally Insured Commercial Banks

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  • Armen Hovakimian
  • Edward J. Kane

Abstract

Mispriced and misadministered deposit insurance imparts risk-shifting incentives to U.S. banks. Regulators are expected to monitor and discipline increases in bank risk exposure that would transfer wealth from the FDIC to bank stockholders. This paper assesses the success regulators had in controlling risk-shifting by U.S. banks during 1985-1994. In contrast to single-equation estimates developed from the option model by others, our simultaneous-equation evidence indicates that regulators failed to prevent large U.S. banks from shifting risk to the FDIC. Moreover, at the margin, banks that are undercapitalized shifted risk more effectively than other sample banks.

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File URL: http://www.nber.org/papers/w5711.pdf
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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5711.

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Date of creation: Aug 1996
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Publication status: published as (Under new title: Changing Effectiveness of Capital Regulation at U.S. Commercial Banks, 1985-1994) Journal of Finance, Vol. 55 (February 2000): 451-461.
Handle: RePEc:nbr:nberwo:5711

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References

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  1. Pyle, David H., 1986. "Capital regulation and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 10(2), pages 189-201, June.
  2. Gary Gorton & Richard Rosen, 1992. "Corporate Control, Portfolio Choice, and the Decline of Banking," NBER Working Papers 4247, National Bureau of Economic Research, Inc.
  3. Marcus, Alan J & Shaked, Israel, 1984. "The Valuation of FDIC Deposit Insurance Using Option-pricing Estimates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(4), pages 446-60, November.
  4. Buser, Stephen A & Chen, Andrew H & Kane, Edward J, 1981. "Federal Deposit Insurance, Regulatory Policy, and Optimal Bank Capital," Journal of Finance, American Finance Association, vol. 36(1), pages 51-60, March.
  5. Pennacchi, George G, 1987. "A Reexamination of the Over- (or Under-) Pricing of Deposit Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(3), pages 340-60, August.
  6. Cooperstein Richard L. & Pennacchi George G. & Redburn F. Stevens, 1995. "The Aggregate Cost of Deposit Insurance: A Multiperiod Analysis," Journal of Financial Intermediation, Elsevier, vol. 4(3), pages 242-271, July.
  7. David Pyle, 1984. "Deregulation and deposit insurance reform," Economic Review, Federal Reserve Bank of San Francisco, issue Spr, pages 5-15.
  8. Allen, Linda & Saunders, Anthony, 1993. "Forbearance and valuation of deposit insurance as a callable put," Journal of Banking & Finance, Elsevier, vol. 17(4), pages 629-643, June.
  9. Edward J. Kane, 1987. "No Room for Weak Links in the Chain of Deposit Insurance Reform," NBER Working Papers 2317, National Bureau of Economic Research, Inc.
  10. Goodman, Laurie S. & Santomero, Anthony M., 1986. "Variable-rate deposit insurance: A re-examination," Journal of Banking & Finance, Elsevier, vol. 10(2), pages 203-218, June.
  11. Kane, Edward J., 1986. "Appearance and reality in deposit insurance: The case for reform," Journal of Banking & Finance, Elsevier, vol. 10(2), pages 175-188, June.
  12. Mark J. Flannery, 1982. "Deposit insurance creates a need for bank regulation," Business Review, Federal Reserve Bank of Philadelphia, issue Jan/Feb, pages 17-31.
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Cited by:
  1. Brock, Philip L., 1998. "Financial safety nets and incentive structures in Latin America," Policy Research Working Paper Series 1993, The World Bank.
  2. Kane, Edward J., 1997. "Making bank risk shifting more transparent," Pacific-Basin Finance Journal, Elsevier, vol. 5(2), pages 143-156, June.
  3. Ho, Chia-Ling & Lai, Gene C. & Lee, Jin-Ping, 2014. "Financial reform and the adequacy of deposit insurance fund: Lessons from Taiwanese experience," International Review of Economics & Finance, Elsevier, vol. 30(C), pages 57-77.

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