Contingent Capital and Bank Risk-Taking among British Banks before World War I

Richard Grossman and Masami Imai

No 2011-003, Wesleyan Economics Working Papers from Wesleyan University, Department of Economics

Abstract: The recent financial turmoil highlights the incentive of highly leveraged financial institutions to take excessive risk, given the protection of limited liability. During the nineteenth and early twentieth century, many banks operated under liability rules which obligated shareholders to bear larger costs of bank insolvency in the form of contingent, or even unlimited liability. This paper examines the empirical relationship between the size of banks’ contingent liability and their risk-taking behavior using data on British banks from 1878-1912. We find that banks with more contingent liability appear to have taken less risk. We also find evidence that the risk-reducing effects of contingent liability were larger for banks with higher leverage, suggesting that contingent capital mitigated moral hazard problem at banks.

Keywords: Contingent Capital; Bank Risk-Taking; British Banks (search for similar items in EconPapers)
Pages: 38 pages
Date: 2011-08
New Economics Papers: this item is included in nep-cta and nep-his
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Citations: View citations in EconPapers (5)

Forthcoming in the Economic History Review

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Persistent link: https://EconPapers.repec.org/RePEc:wes:weswpa:2011-003

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