Bailouts, Contagion, and Bank Risk-Taking

Lev Ratnovski () and Giovanni Dell'ariccia

No 133, 2012 Meeting Papers from Society for Economic Dynamics

Abstract: We revisit the link between bailouts and bank risk taking. The expectation of government support to failing banks (bailout) creates moral hazard and encourages risk-taking. However, when a bank's success depends on both its idiosyncratic risk and the overall stability of the banking system, a government's commitment to shield banks from contagion may increase their incentives to invest prudently. We explore these issues in a simple model of financial intermediation where a bank's survival depends on another bank's success. We show that the positive effect from systemic insurance dominates the classical moral hazard effect when the risk of contagion is high.

Date: 2012
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cta and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed012:133

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