Does “skin in the game” reduce risk taking? Leverage, liability and the long-run consequences of new deal banking reforms

Kris James Mitchener and Gary Richardson

Explorations in Economic History, 2013, vol. 50, issue 4, 508-525

Abstract: This essay examines how the Banking Acts of the 1933 and 1935 and related New Deal legislation influenced risk taking in the financial sector of the U.S. economy. The analysis focuses on contingent liability of bank owners for losses incurred by their firms and how the elimination of this liability influenced leverage and lending by commercial banks. Using a new panel data set, we find contingent liability reduced risk taking. In states with contingent liability, banks used less leverage and converted each dollar of capital into fewer loans, and thus could survive larger loan losses (as a fraction of their portfolio) than banks in limited liability states. In states with limited liability, banks took on more leverage and risk, particularly in states that required banks with limited liability to join the Federal Deposit Insurance Corporation. In the long run, the New Deal replaced a regime of contingent liability with deposit insurance, stricter balance sheet regulation, and increased capital requirements, shifting the onus of risk management from bankers to state and federal regulators.

Keywords: Risk Taking; Incentives; Double Liability; Contingent Liability; Leverage; Great Depression; New Deal; Banking Act of 1935; Glass–Steagall Act (search for similar items in EconPapers)
JEL-codes: E44 G28 G33 N12 N22 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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Related works:
Working Paper: Does "Skin in the Game" Reduce Risk Taking? Leverage, Liability and the Long-Run Consequences of New Deal Banking Reforms (2013)
Chapter: Does "Skin in the Game" Reduce Risk Taking? Leverage, Liability, and the Long-run Consequences of the New Deal Banking Reforms (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:exehis:v:50:y:2013:i:4:p:508-525

DOI: 10.1016/j.eeh.2013.06.002

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