Moral hazard and the financial structure of banks

This paper analyzes whether risk shifting took place in the European Union’s banking sector in 2002–2009. We also identify the type of risk shifting, if any, in the sample. In addition, our method provides a way to determine which variables incentivize/disincentivize risk shifting. Our main findings suggest that banks shifted risk to non-depository creditors. As regards banking policy, the analysis indicates that (i) the three pillars of Basel II do not seem to be effective in controlling risk shifting incentives, (ii) generous deposit insurance schemes seem to incentivize risk shifting, and (iii) in tune with the new rules on conservation buffers in Basel III, incentives to shift risk seem to be weaker in banks with a capital buffer.