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Safer ratios, riskier portfolios: Banks׳ response to government aid

Ran Duchin and Denis Sosyura

Journal of Financial Economics, 2014, vol. 113, issue 1, 1-28

Abstract: Using novel data on bank applications to the Troubled Asset Relief Program (TARP), we study the effect of government assistance on bank risk taking. Bailed-out banks initiate riskier loans and shift assets toward riskier securities after receiving government support. However, this shift in risk occurs mostly within the same asset class and, therefore, remains undetected by regulatory capital ratios, which indicate improved capitalization at bailed-out banks. Consequently, these banks appear safer according to regulatory ratios, but show an increase in volatility and default risk. These findings are robust to controlling for credit demand and account for selection of TARP recipients by exploiting banks׳ geography-based political connections as an instrument for bailout approvals.

Keywords: Bailout; TARP; Risk; Lending; Financial crisis; Moral hazard; Banking (search for similar items in EconPapers)
JEL-codes: E51 G01 G21 G28 (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1016/j.jfineco.2014.03.005

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Handle: RePEc:eee:jfinec:v:113:y:2014:i:1:p:1-28