Government Guarantees, Transparency, and Bank Risk Taking

Tito Cordella, Giovanni Dell’Ariccia () and Robert Marquez
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Giovanni Dell’Ariccia: International Monetary Fund and CEPR
Robert Marquez: University of California, Davis
Authors registered in the RePEc Author Service: Giovanni Dell'ariccia

IMF Economic Review, 2018, vol. 66, issue 1, No 5, 116-143

Abstract: Abstract We present a model of bank risk taking and government guarantees. Levered banks take excessive risk as their actions are not fully priced at the margin by debt holders. The impact of government guarantees on bank risk taking depends critically on the portion of bank investors that can observe bank behavior and hence price debt at the margin. Greater guarantees increase risk taking (moral hazard) when informed investors hold a sufficiently large fraction of liabilities. But, otherwise, they reduce risk taking by increasing the profits of the bank (franchise value effect). The results extend to the case in which information disclosure and, thus, the portion of informed investors is endogenous but costly. The model also shows that, when bank capital is endogenous, public guarantees lead unequivocally to an increase in bank leverage and an associated increase in risk taking. The analysis points to a complex relationship between prudential policy and the institutional framework governing bank resolution and bailouts.

JEL-codes: G1 G21 G28 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (10)

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DOI: 10.1057/s41308-018-0049-5

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