Contingent Capital and Bank Risk‐Taking Among British Banks Before the First World War

24 Pages Posted: 19 Dec 2012

See all articles by Richard S. Grossman

Richard S. Grossman

Wesleyan University - Economics Department; Institute for Quantitative Social Sciences - Harvard University; Centre for Economic Policy Research

Masami Imai

Wesleyan University

Date Written: February 2013

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 article examines the empirical relationship between the size of banks' contingent liability and their risk‐taking behaviour using data on British banks from 1878 to 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 the moral hazard problem at banks.

Suggested Citation

Grossman, Richard S. and Imai, Masami, Contingent Capital and Bank Risk‐Taking Among British Banks Before the First World War (February 2013). The Economic History Review, Vol. 66, Issue 1, pp. 132-155, 2013. Available at SSRN: https://ssrn.com/abstract=2191380 or http://dx.doi.org/10.1111/j.1468-0289.2011.00638.x

Richard S. Grossman (Contact Author)

Wesleyan University - Economics Department ( email )

Middletown, CT 06459
United States
(860) 685-2356 (Phone)
(860) 685-2781 (Fax)

HOME PAGE: http://rgrossman.web.wesleyan.edu

Institute for Quantitative Social Sciences - Harvard University ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

Centre for Economic Policy Research ( email )

London
United Kingdom

Masami Imai

Wesleyan University ( email )

Middletown, CT 06459
United States
860-685-2155 (Phone)

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