How Important Is Moral Hazard For Distressed Banks?
Charles A. Dice Center Working Paper No. 2020-09
98 Pages Posted: 15 May 2020 Last revised: 27 Jul 2020
Date Written: May 12, 2020
The moral hazard incentives of the bank safety net predict that distressed banks take on more risk and higher leverage. Since many factors reduce these incentives, including charter value, regulation, and managerial incentives, the net economic effect of these incentives is an empirical question. We provide evidence on this question using two distinct periods that include financial crises and are subject to different regulatory regimes (1985–1994, 2005–2014). We find that distressed banks reduce their leverage and decrease observable measures of riskiness, which is inconsistent with the view that, on average, moral hazard incentives dominate distressed bank leverage and risk-taking policies.
Keywords: Banks, distress, moral hazard, deleveraging, leverage, risk
JEL Classification: G11, G21, G33
Suggested Citation: Suggested Citation