The Effect of Debt Guarantees and Risk Exposure on Bank Salaries in Switzerland

It is well known that state bank debt guarantees create a significant moral hazard problem by encouraging banks to invest in more risk in the pursuit of higher returns, knowing that the state will bail them out if they fail. Researchers have recently postulated that the higher returns stemming from investing in more risk may lead banks to share the proceeds with their personnel through higher wages. In this case, moral hazard effects should manifest themselves in wages that exceed the pay that banks unshielded by debt guarantees offer. Based on this rationale and employing an econometric approach that makes it possible to measure the impact of debt guarantees and risk exposure on wages directly, we find clear evidence of such moral hazard effects in the Swiss banking industry. In light of these findings, it seems important to ensure that remuneration structures do not inadvertently reward risk enhancing behavior. Our results also seem relevant for ongoing reforms of public liquidity backstops and capital frameworks, where the design of compensation and guarantee mechanisms aims to mitigate moral hazard effects.