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Government guarantees and the risk-taking of financial institutions: evidence from a regulatory experiment

Author

Listed:
  • Christina Atanasova

    () (Simon Fraser University)

  • Mingxin Li

    () (Simon Fraser University)

  • Yevgeny Mugerman

    () (Bar-Ilan University)

  • Mehrdad Rastan

    () (Financial Institutions Commission)

Abstract

The potential dark side of government guarantees, introduced to mitigate concerns about financial stability during economic downturns, is that they may create incentives for excessive risk-taking. In a low-interest rate environment, this effect may be even stronger as financial institutions try to “reach for yield”. In this paper, we use the 2008 introduction of unlimited deposit insurance for all credit unions in the province of British Columbia, Canada, to examine the effect of government guarantees on financial institutions’ earnings uncertainty. We find that the policy change resulted in an economically and statistically significant decrease in earnings uncertainty. In addition, although deposits grew following the policy change, lending did not increase and instead capitalization ratios improved. Overall, our results suggest that the provincial government guarantee boosted depositor confidence and increased the flow of funds to the insured financial institutions. We do not find support for the risk-taking hypothesis but instead show that risk management improved following the policy change. Finally, the effect of the policy change was stronger for smaller, more levered credit unions as well as those with fewer members and smaller market share.

Suggested Citation

  • Christina Atanasova & Mingxin Li & Yevgeny Mugerman & Mehrdad Rastan, 2019. "Government guarantees and the risk-taking of financial institutions: evidence from a regulatory experiment," Journal of Asset Management, Palgrave Macmillan, vol. 20(6), pages 476-492, October.
  • Handle: RePEc:pal:assmgt:v:20:y:2019:i:6:d:10.1057_s41260-019-00128-2
    DOI: 10.1057/s41260-019-00128-2
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    More about this item

    Keywords

    Risk-taking; Deposit insurance; Financial cooperatives; Earnings volatility;
    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
    • L31 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Nonprofit Institutions; NGOs; Social Entrepreneurship
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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