Bailouts of Systemically Relevant Banks Do Not Create Moral Hazard
8 Pages Posted: 16 Jul 2016
Date Written: July 16, 2016
Many economists and policy-makers believe that bailouts of systemically important financial institutions (SIFIs), though unavoidable ex post, are inefficient ex ante: The expectation of such bailouts is said to lead to moral hazard in the form of excessive risk taking. We argue that this view may be true for non-systemically relevant banks, but misleading for SIFIs. To the degree that an institution neglects the systemic damage of its potential failure it will take excessive risk even under laissez-faire, i.e., in the absence of a state and hence of bailouts. Bailouts of such institutions, even if anticipated ex ante, are likely to reduce moral hazard.
Keywords: Banking, Bailout, SIFIs, Financial Stability, Incentives
JEL Classification: G21, G28, C72, C73, L51
Suggested Citation: Suggested Citation