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Contingent Capital and Bank Risk-Taking among British Banks before World War I

Author

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  • Richard S. Grossman

    () (Department of Economics, Wesleyan University)

  • Masami Imai

    () (Department of Economics, Wesleyan University)

Abstract

The recent financial turmoil highlights the incentive of highly leveraged financial institutions to take excessive risk, given the protection of limited liability. During the nineteenth and early twentieth century, many banks operated under liability rules which obligated shareholders to bear larger costs of bank insolvency in the form of contingent, or even unlimited liability. This paper examines the empirical relationship between the size of banks’ contingent liability and their risk-taking behavior using data on British banks from 1878-1912. We find that banks with more contingent liability appear to have taken less risk. We also find evidence that the risk-reducing effects of contingent liability were larger for banks with higher leverage, suggesting that contingent capital mitigated moral hazard problem at banks.

Suggested Citation

  • Richard S. Grossman & Masami Imai, 2011. "Contingent Capital and Bank Risk-Taking among British Banks before World War I," Wesleyan Economics Working Papers 2011-003, Wesleyan University, Department of Economics.
  • Handle: RePEc:wes:weswpa:2011-003
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    References listed on IDEAS

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    Cited by:

    1. Colvin, Christopher L. & de Jong, Abe & Fliers, Philip T., 2015. "Predicting the past: Understanding the causes of bank distress in the Netherlands in the 1920s," Explorations in Economic History, Elsevier, vol. 55(C), pages 97-121.
    2. Murphy, Gareth & Walsh, Mark & Willison, Matthew, 2012. "Financial Stability Paper No 16: Precautionary contingent capital," Bank of England Financial Stability Papers 16, Bank of England.
    3. Turner, John D., 2014. "Financial history and financial economics," QUCEH Working Paper Series 14-03, Queen's University Belfast, Queen's University Centre for Economic History.
    4. Andrew G. Haldane, 2012. "Control Rights (And Wrongs)," Economic Affairs, Wiley Blackwell, vol. 32(2), pages 47-58, June.

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    Keywords

    Contingent Capital; Bank Risk-Taking; British Banks;

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