Government guarantees and the risk-taking of financial institutions: evidence from a regulatory experiment

Christina Atanasova (), Mingxin Li (), Yevgeny Mugerman and Mehrdad Rastan ()
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Christina Atanasova: Simon Fraser University
Mingxin Li: Simon Fraser University
Mehrdad Rastan: Financial Institutions Commission

Journal of Asset Management, 2019, vol. 20, issue 6, No 6, 476-492

Abstract: Abstract The potential dark side of government guarantees, introduced to mitigate concerns about financial stability during economic downturns, is that they may create incentives for excessive risk-taking. In a low-interest rate environment, this effect may be even stronger as financial institutions try to “reach for yield”. In this paper, we use the 2008 introduction of unlimited deposit insurance for all credit unions in the province of British Columbia, Canada, to examine the effect of government guarantees on financial institutions’ earnings uncertainty. We find that the policy change resulted in an economically and statistically significant decrease in earnings uncertainty. In addition, although deposits grew following the policy change, lending did not increase and instead capitalization ratios improved. Overall, our results suggest that the provincial government guarantee boosted depositor confidence and increased the flow of funds to the insured financial institutions. We do not find support for the risk-taking hypothesis but instead show that risk management improved following the policy change. Finally, the effect of the policy change was stronger for smaller, more levered credit unions as well as those with fewer members and smaller market share.

Keywords: Risk-taking; Deposit insurance; Financial cooperatives; Earnings volatility (search for similar items in EconPapers)
JEL-codes: G21 G22 G28 L31 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1057/s41260-019-00128-2

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