Safer Ratios, Riskier Portfolios: Banks’ Response to Government Aid

87 Pages Posted: 12 Sep 2011 Last revised: 27 May 2014

Ran Duchin

University of Washington - Michael G. Foster School of Business

Denis Sosyura

University of Michigan, Stephen M. Ross School of Business

Date Written: February 19, 2014

Abstract

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.

Keywords: bailout, TARP, risk, lending, financial crisis, moral hazard, banking

JEL Classification: E51, G01, G21, G28

Suggested Citation

Duchin, Ran and Sosyura, Denis, Safer Ratios, Riskier Portfolios: Banks’ Response to Government Aid (February 19, 2014). Journal of Financial Economics (JFE), 113, 1-28 (2014). Available at SSRN: https://ssrn.com/abstract=1925710 or http://dx.doi.org/10.2139/ssrn.1925710

Ran Duchin (Contact Author)

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

Denis Sosyura

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

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