Unequal and Unstable: Income Inequality and Bank Risk

67 Pages Posted: 20 Jul 2020 Last revised: 12 Feb 2021

See all articles by Yuliyan Mitkov

Yuliyan Mitkov

University of Bonn

Ulrich Schüwer

Goethe University Frankfurt - Department of Finance; Leibniz Institute for Financial Research SAFE

Date Written: June 15, 2020

Abstract

We provide evidence that regions in the U.S. with higher income inequality tend to have a riskier banking sector. However, not all banks are more risky, as reflected in a higher dispersion of bank risk. We show how a model based on risk-shifting incentives where banks channel insured deposits into subprime loans can account for both findings. In equilibrium, a competition to risk-shift emerges, leading to a subprime lending boom in which loans to high-risk borrowers carry negative NPVs. Some banks engage in risk-shifting by lending to high-risk subprime borrowers, while the rest specialize in lending to low-risk prime borrowers.

Keywords: Inequality, bank risk, risk-shifting, mortgage credit, banking competition

JEL Classification: G11, G21, G28, G51

Suggested Citation

Mitkov, Yuliyan and Schüwer, Ulrich, Unequal and Unstable: Income Inequality and Bank Risk (June 15, 2020). Available at SSRN: https://ssrn.com/abstract=3636750 or http://dx.doi.org/10.2139/ssrn.3636750

Yuliyan Mitkov (Contact Author)

University of Bonn ( email )

Regina-Pacis-Weg 3
Postfach 2220
Bonn, D-53012
Germany

Ulrich Schüwer

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Theodor-W.-Adorno-Platz 3
Frankfurt, 60323
Germany

HOME PAGE: http://www.wiwi.uni-frankfurt.de/de/abteilungen/finance/home.html

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

HOME PAGE: http://safe-frankfurt.de/

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