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Excessive Lending, Leverage, and Risk-Taking in the Presence of Bailout Expectations

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  • Mr. Andréas Georgiou

Abstract

The financial crisis that began in 2007 has brought to the fore the issues of excesses in lending, leverage, and risk-taking as some of the fundamental causes of this crisis. At the same time, in dealing with the financial crisis there have been large scale interventions by governments, often referred to as bailouts of the lenders. This paper presents a framework where rational economic agents engage in ex ante excessive lending, borrowing, and risk-taking if creditors assign a positive probability to being bailed out. The paper also offers some thoughts on policy implications. It argues that it would be most productive for the long run if lending institutions were not bailed out. If the continuing existence of an institution was deemed essential, assistance should take the form of capital injections that dilute the equity of existing owners.

Suggested Citation

  • Mr. Andréas Georgiou, 2009. "Excessive Lending, Leverage, and Risk-Taking in the Presence of Bailout Expectations," IMF Working Papers 2009/233, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2009/233
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    References listed on IDEAS

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    1. Jaffee, Dwight M & Modigliani, Franco, 1969. "A Theory and Test of Credit Rationing," American Economic Review, American Economic Association, vol. 59(5), pages 850-872, December.
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    3. Larry A. Sjaastad, 1983. "International Debt Quagmire — to Whom do We Owe It?," The World Economy, Wiley Blackwell, vol. 6(3), pages 305-324, September.
    4. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
    5. Dwight M. Jaffee & Thomas Russell, 1976. "Imperfect Information, Uncertainty, and Credit Rationing," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 90(4), pages 651-666.
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    Cited by:

    1. Colignatus, Thomas, 2020. "Forum Theory & A National Assembly of Science and Learning," MPRA Paper 98568, University Library of Munich, Germany, revised 09 Feb 2020.

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    Keywords

    WP; lending institution;

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