Government Guarantees and Banks’ Income Smoothing

Manuela M. Dantas (), Kenneth J. Merkley () and Felipe B. G. Silva ()
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Manuela M. Dantas: California State University
Kenneth J. Merkley: Indiana University
Felipe B. G. Silva: University of Missouri

Journal of Financial Services Research, 2023, vol. 63, issue 2, No 3, 123-173

Abstract: Abstract We propose four channels through which government guarantees affect banks’ incentives to smooth income. Empirically, we exploit two complementary settings that represent plausible exogenous changes in government guarantees: the increase in implicit guarantees following the creation of the Eurozone and the removal of explicit guarantees granted to the Landesbanken. We show that increases (decreases) in government guarantees are associated with significant decreases (increases) in banks’ income smoothing. Taken together, our results largely corroborate the predominance of a tail-risk channel, wherein government guarantees reduce banks’ tail risk, thereby reducing managers’ incentives to engage in income smoothing.

Keywords: Government guarantees; Income smoothing; International financial stability (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/s10693-023-00398-3

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