Bank Bailouts, Interventions, and Moral Hazard

68 Pages Posted: 8 Jun 2016

See all articles by Lammertjan Dam

Lammertjan Dam

University of Groningen - Faculty of Economics and Business

Michael Koetter

Halle Institute for Economic Research

Date Written: 2011

Abstract

To test if safety nets create moral hazard in the banking industry, we develop a simultaneous structural two-equations model that specifies the probability of a bailout and banks' risk taking.We identify the effect of expected bailout probabilities on risk taking using exclusion restrictions based on regional political, supervisor, and banking market traits. The sample includes all observed capital preservation measures and distressed exits in the German banking industry during 1995-2006. The marginal effect of risk with respect to bailout expectations is 7.2 basis points. A change of bailout expectations by two standard deviations increases the probability of official distress from 6.2% to 9.9%. Only interventions directly targeting bank management and, to a lesser extent, penalties mitigate moral hazard. Weak interventions, such as warnings, do not reduce moral hazard.

Keywords: Banking, supervision, moral hazard, intervention, bailouts

JEL Classification: C30, C78, G21, G28, L51

Suggested Citation

Dam, Lammertjan and Koetter, Michael, Bank Bailouts, Interventions, and Moral Hazard (2011). Bundesbank Series 2 Discussion Paper No. 2011,10, Available at SSRN: https://ssrn.com/abstract=2794065

Lammertjan Dam (Contact Author)

University of Groningen - Faculty of Economics and Business ( email )

Postbus 72
9700 AB Groningen
Netherlands
+31-50-3636518 (Phone)

Michael Koetter

Halle Institute for Economic Research ( email )

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

HOME PAGE: http://www.iwh-halle.de/en/about-the-iwh/people/detail/michael-koetter/

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