The Impact of Public Guarantees on Bank Risk Taking: Evidence from a Natural Experiment

Review of Finance 18 (2014), 457-488

48 Pages Posted: 13 Jan 2010 Last revised: 17 Feb 2015

See all articles by Reint Gropp

Reint Gropp

Halle Institute for Economic Research

Christian Gründl

EBS Universität für Wirtschaft und Recht - EBS Business School

Andre Guettler

University of Ulm - Department of Mathematics and Economics; Halle Institute for Economic Research

Multiple version iconThere are 4 versions of this paper

Date Written: February 27, 2013

Abstract

In 2001, government guarantees for savings banks in Germany were removed following a lawsuit. We use this natural experiment to examine the effect of government guarantees on bank risk taking. The results suggest that banks whose government guarantee was removed reduced credit risk by cutting off the riskiest borrowers from credit. Using a difference-in-differences approach we show that none of these effects are present in a control group of German banks to whom the guarantee was not applicable. Furthermore, savings banks adjusted their liabilities away from risk-sensitive debt instruments after the removal of the guarantee, while we do not observe this for the control group. We also document that yield spreads of savings banks' bonds increased significantly right after the announcement of the decision to remove guarantees, while the yield spread of a sample of bonds issued by the control group remained unchanged. The evidence implies that public guarantees may be associated with substantial moral hazard effects.

Keywords: banking, public guarantees, credit risk, moral hazard, market discipline

JEL Classification: G21, G28, G32

Suggested Citation

Gropp, Reint and Gründl, Christian and Guettler, Andre, The Impact of Public Guarantees on Bank Risk Taking: Evidence from a Natural Experiment (February 27, 2013). Review of Finance 18 (2014), 457-488. Available at SSRN: https://ssrn.com/abstract=1536032

Reint Gropp

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

Christian Gründl

EBS Universität für Wirtschaft und Recht - EBS Business School ( email )

Gustav-Stresemann-Ring 3
65189 Wiesbaden
Germany

Andre Guettler (Contact Author)

University of Ulm - Department of Mathematics and Economics ( email )

Helmholzstrasse
Ulm, D-89081
Germany

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

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