Unequal and Unstable: Income Inequality and Bank Risk

Yuliyan Mitkov (ymitkov@uni-bonn.de) and Ulrich Schüwer (schuewer@uni-bonn.de)

CRC TR 224 Discussion Paper Series from University of Bonn and University of Mannheim, Germany

Abstract: We provide evidence that regions in the U.S. with higher income inequality tend to have a riskier banking sector. However, not all banks are more risky, as reflected in a higher dispersion of bank risk. We show how a model based on risk-shifting incentives where banks channel insured deposits into subprime loans can account for both findings. In equilibrium, a competition to risk-shift emerges, leading to a subprime lending boom in which loans to high-risk borrowers carry negative NPVs. Some banks engage in risk-shifting by lending to high-risk subprime borrowers, while the rest specialize in lending to low-risk prime borrowers.

Keywords: Inequality; Financial stability; Agency costs; Composition of credit; Banking competition (search for similar items in EconPapers)
JEL-codes: G11 G21 G28 G51 (search for similar items in EconPapers)
Pages: 67
Date: 2021-01
New Economics Papers: this item is included in nep-ban and nep-fdg
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