Safer Ratios, Riskier Portfolios: Banks’ Response to Government Aid
University of Washington - Michael G. Foster School of Business
The Stephen M. Ross School of Business at the University of Michigan
February 19, 2014
Journal of Financial Economics (JFE), Forthcoming
Ross School of Business Paper No. 1165
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 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.
Number of Pages in PDF File: 87
Keywords: bailout, TARP, risk, lending, financial crisis, moral hazard, banking
JEL Classification: E51, G01, G21, G28Accepted Paper Series
Date posted: September 12, 2011 ; Last revised: March 20, 2014
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