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Banks without Parachutes – Competitive Effects of Government Bail-out Policies

  • Hendrik Hakenes

    ()

    (Max Planck Institute for Research on Collective Goods, Bonn, Germany)

  • Isabel Schnabel

    ()

    (Max Planck Institute for Research on Collective Goods, Bonn, Germany)

The explicit or implicit protection of banks through government bail-out policies is a universal phenomenon. We analyze the competitive effects of such policies in two models with different degrees of transparency in the banking sector. Our main result is that the bail-out policy unambiguously leads to higher risk-taking at those banks that do not enjoy a bail-out guarantee. The reason is that the prospect of a bail-out induces the protected bank to expand, thereby intensifying competition in the deposit market and depressing other banks’ margins. In contrast, the effects on the protected bank’s risk-taking and on welfare depend on the transparency of the banking sector.

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Paper provided by Max Planck Institute for Research on Collective Goods in its series Working Paper Series of the Max Planck Institute for Research on Collective Goods with number 2004_12.

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Length: 33 pages
Date of creation: Nov 2004
Date of revision:
Handle: RePEc:mpg:wpaper:2004_12
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