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

European Banking Center Discussion Paper No. 2010-21S

CentER Discussion Paper Series No. 2010-69S

48 Pages Posted: 6 Jul 2010

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 Güttler

EBS Universität für Wirtschaft und Recht - EBS Business School

Multiple version iconThere are 4 versions of this paper

Date Written: March 18, 2010

Abstract

In 2001, government guarantees for savings banks in Germany were removed following a law suit. We use this natural experiment to examine the effect of government guarantees on bank risk taking, using a large data set of matched bank/borrower information. The results suggest that banks whose government guarantee was removed reduced credit risk by cutting off the riskiest borrowers from credit. At the same time, the banks also increased interest rates on their remaining borrowers. The effects are economically large: the Z-Score of average borrowers increased by 7% and the average loan size declined by 13%. Remaining borrowers paid 57 basis points higher interest rates, despite their higher quality. Using a difference-in-differences approach we show that the effect is larger for banks that ex ante benefited more from the guarantee. We show that both the credit quality of new customers improved (screening) and that the loans of existing riskier borrowers were less likely to be renewed (monitoring), after the removal of public guarantees. Public guarantees seem to be associated with substantial moral hazard effects.

Keywords: Banking, Public Guarantees, Credit Risk, Moral Hazard

JEL Classification: G21, G28, G32

Suggested Citation

Gropp, Reint and Gründl, Christian and Güttler, Andre, The Impact of Public Guarantees on Bank Risk Taking: Evidence from a Natural Experiment (March 18, 2010). European Banking Center Discussion Paper No. 2010-21S. Available at SSRN: https://ssrn.com/abstract=1635249 or http://dx.doi.org/10.2139/ssrn.1635249

Reint Gropp (Contact Author)

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 Güttler

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

Gustav-Stresemann-Ring 3
65189 Wiesbaden
Germany

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