Contingent Capital and Bank Risk-Taking among British Banks before World War I
AbstractThe recent financial turmoil highlights the incentive of highly leveraged financial institutions to take excessive risk, given the protection of limited liability. During the nineteenth and early twentieth century, many banks operated under liability rules which obligated shareholders to bear larger costs of bank insolvency in the form of contingent, or even unlimited liability. This paper examines the empirical relationship between the size of banks’ contingent liability and their risk-taking behavior using data on British banks from 1878-1912. We find that banks with more contingent liability appear to have taken less risk. We also find evidence that the risk-reducing effects of contingent liability were larger for banks with higher leverage, suggesting that contingent capital mitigated moral hazard problem at banks.
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Bibliographic InfoPaper provided by Wesleyan University, Department of Economics in its series Wesleyan Economics Working Papers with number 2011-003.
Length: 38 pages
Date of creation: Aug 2011
Date of revision:
Publication status: forthcoming in the Economic History Review
Contingent Capital; Bank Risk-Taking; British Banks;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-09-22 (All new papers)
- NEP-CTA-2011-09-22 (Contract Theory & Applications)
- NEP-HIS-2011-09-22 (Business, Economic & Financial History)
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