Government Guarantees, Transparency, and Bank Risk-Taking
This paper presents a model of bank risk taking and government guarantees. Levered banks take excessive risk, as their actions are not fully priced at the margin by debt holders. The impact of government guarantees on bank risk taking depends criti...
| Main Authors: | , , |
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| Format: | Working Paper |
| Language: | English en_US |
| Published: |
World Bank, Washington, DC
2017
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| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/468401487165710483/Government-guarantees-transparency-and-bank-risk-taking http://hdl.handle.net/10986/26138 |
| Summary: | This paper presents a model of bank risk
taking and government guarantees. Levered banks take
excessive risk, as their actions are not fully priced at the
margin by debt holders. The impact of government guarantees
on bank risk taking depends critically on the portion of
bank investors that can observe bank behavior and hence
price debt at the margin. Greater guarantees increase risk
taking (moral hazard) when informed investors hold a
sufficiently large fraction of liabilities. Otherwise,
greater guarantees reduce risk taking by increasing the
profits of the bank (franchise value effect). The results
extend to the case in which information disclosure, and thus
the portion of informed investors, is endogenous but costly.
The model also shows that when bank capital is endogenous,
public guarantees lead unequivocally to an increase in bank
leverage and an associated increase in risk taking. The
analysis points to a complex relationship between prudential
policy and the institutional framework governing bank
resolution and bailouts. |
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