Does “Skin in the Game” Reduce Risk Taking? Leverage, Liability and the Long-Run Consequences of New Deal Financial Reforms
We examine how the Banking Acts of the 1933 and 1935 and related New Deal legislation influenced risk taking in the financial sector of the U.S. economy. Our analysis focuses on contingent liability of bank owners for losses incurred by their firms and how the elimination of this liability influenced leverage and lending by commercial banks. Using a new panel data set that compares balance sheets of state and national banks, we find contingent liability reduced risk taking, particularly when coupled with rules requiring banks to join the Federal Deposit Insurance Corporation. Leverage ratios are higher in states with limited liability for bank owners. Banks in states with contingent liability converted each dollar of capital into fewer loans, and thus could sustain larger loan losses (as a fraction of their portfolio) than banks in limited liability states. The New Deal replaced a regime of contingent liability with stricter balance sheet regulation and increased capital requirements, shifting the onus of risk management from banks to state and federal regulators. By separating investment banks from commercial banks, the Glass-Steagall Act left investment banks to manage their own leverage, a feature of financial regulation that, in part, depended on their partnership structure.
|Date of creation:||2013|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: +44 (0) 2476 523202
Fax: +44 (0) 2476 523032
Web page: http://www2.warwick.ac.uk/fac/soc/economics/research/centres/cage/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Edward J. Kane & Asli Demirguc-Kunt, 2001.
"Deposit Insurance Around the Globe: Where Does it Work?,"
NBER Working Papers
8493, National Bureau of Economic Research, Inc.
- Asli Demirguc-Kunt & Edward J. Kane, 2002. "Deposit Insurance Around the Globe: Where Does It Work?," Journal of Economic Perspectives, American Economic Association, vol. 16(2), pages 175-195, Spring.
- Demirguc-Kunt, Asl' & Kane, Edward J., 2001. "Depositinsurance around the globe : where does it work?," Policy Research Working Paper Series 2679, The World Bank.
- Charles W. Calomiris & Berry Wilson, 2004. "Bank Capital and Portfolio Management: The 1930s "Capital Crunch" and the Scramble to Shed Risk," The Journal of Business, University of Chicago Press, vol. 77(3), pages 421-456, July.
- Randall S. Kroszner, 1998. "Rethinking Bank Regulation: A Review Of The Historical Evidence," Journal of Applied Corporate Finance, Morgan Stanley, vol. 11(2), pages 48-58.
- Kroszner, Randall S & Rajan, Raghuram G, 1994. "Is the Glass-Steagall Act Justified? A Study of the U.S. Experience with Universal Banking before 1933," American Economic Review, American Economic Association, vol. 84(4), pages 810-32, September.
- Berry K. Wilson & Edward J. Kane, 1996. "The Demise of Double Liability as an Optimal Contract for Large-Bank Stockholders," NBER Working Papers 5848, National Bureau of Economic Research, Inc.
- Vernon, Jack R, 1970. "Ownership and Control Among Large Member Banks," Journal of Finance, American Finance Association, vol. 25(3), pages 651-57, June.
When requesting a correction, please mention this item's handle: RePEc:cge:wacage:118. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jane Snape)
If references are entirely missing, you can add them using this form.