Banks without parachutes: Competitive effects of government bail-out policies |
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Affiliation: | 1. Institute of Financial Economics, University of Hannover, Königsworther Platz 1, 30167 Hannover, Germany;2. Max Planck Institute for Research on Collective Goods, Bonn, Germany;3. Department of Law and Economics, Johannes Gutenberg University Mainz, 55099 Mainz, Germany;4. Centre for Economic Policy Research (CEPR), London |
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Abstract: | We analyze the competitive effects of government bail-out policies in two models with different degrees of transparency in the banking sector. Our main result is that bail-outs lead to higher risk-taking among the protected bank’s competitors, independently of transparency. The reason is that the prospect of a bail-out induces the protected bank to expand, which intensifies competition in the deposit market, depresses other banks’ margins, and thereby increases risk-taking incentives. Contrary to conventional wisdom, protected banks may take lower risks when transparency in the banking sector is low and the deposit supply is sufficiently elastic. |
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