Government Guarantees and the Risk-Taking of Financial Institutions: Evidence from a Regulatory Experiment

Journal of Asset Management, 2019

42 Pages Posted: 12 Aug 2019

See all articles by Christina V. Atanasova

Christina V. Atanasova

Simon Fraser University

Mingxin Li

Canada Mortgage and Housing Corporation

Yevgeny Mugerman

Bar Ilan University

Mehrdad Rastan

Financial Institutions Commission

Date Written: July 31, 2019

Abstract

The potential dark side of government guarantees, introduced to mitigate concerns about financial stability during economic downturns, is that they may create incentives for excessive risk-taking. In a low-interest rate environment, this effect maybe even stronger as financial institutions try to "reach for yield". In this paper, we use the 2008 introduction of unlimited deposit insurance for all credit unions in the province of British Columbia, Canada, to examine the effect of government guarantees on financial institutions' earnings uncertainty. We find that the policy change resulted in an economically and statistically significant decrease in earnings uncertainty. In addition, although deposits grew following the policy change, lending did not increase and instead capitalization ratios improved. Overall, our results suggest that the provincial government guarantee boosted depositor confidence and increased the flow of funds to the insured financial institutions. We do not find support for the risk-taking hypothesis but instead show that risk-management improved following the policy change. Finally, the effect of the policy change was stronger for smaller, more levered credit unions as well as those with fewer members and smaller market share.

Keywords: Risk taking, Deposit insurance, Financial cooperatives, Earnings volatility

JEL Classification: G21, G28, L31, G22

Suggested Citation

Atanasova, Christina V. and Li, Mingxin and Mugerman, Yevgeny and Rastan, Mehrdad, Government Guarantees and the Risk-Taking of Financial Institutions: Evidence from a Regulatory Experiment (July 31, 2019). Journal of Asset Management, 2019, Available at SSRN: https://ssrn.com/abstract=3429713

Christina V. Atanasova

Simon Fraser University ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

Mingxin Li

Canada Mortgage and Housing Corporation ( email )

700 Montreal Rd
Ottawa, Ontario K1A 0P7
Canada

Yevgeny Mugerman (Contact Author)

Bar Ilan University ( email )

Ramat Gan
5290002
Israel

Mehrdad Rastan

Financial Institutions Commission ( email )

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