International Evidence on Government Support and Risk-Taking in the Banking Sector

Abstract: Government support to banks through the provision of explicit or implicit guarantees can affect the willingness of banks to take on risk by reducing market discipline or by increasing charter value. We use an international sample of bank data and government support to banks for the periods 2003-2004 and 2009-2010. We find that more government support is associated with more risk-taking by banks, especially during the financial crisis (2009-10), even after controlling for several bank-specific and country-level factors. We use several measures of government support and bank risk-taking, and the results are robust to various possible misspecification issues. We also find that restricting banks’ range of activities ameliorates the moral hazard problem. We propose that policy measures to counteract this moral hazard problem should be geared towards strengthening market discipline in the banking sector.