The Impact of Public Guarantees on Bank Risk Taking

Evidence from a Natural Experiment

R. Gropp, C. Grundl, A. Guttler

Research output: Working paperDiscussion paperOther research output

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Abstract

In 2001, government guarantees for savings banks in Germany were removed following a law suit. We use this natural experiment to examine the effect of government guarantees on bank risk taking, using a large data set of matched bank/borrower information. The results suggest that banks whose government guarantee was removed reduced credit risk by cutting off the riskiest borrowers from credit. At the same time, the banks also increased interest rates on their remaining borrowers. The effects are economically large: the Z-Score of average borrowers increased by 7% and the average loan size declined by 13%. Remaining borrowers paid 57 basis points higher interest rates, despite their higher quality. Using a difference-in-differences approach we show that the effect is larger for banks that ex ante benefitted more from the guarantee. We show that both the credit quality of new customers improved (screening) and that the loans of existing riskier borrowers were less likely to be renewed (monitoring), after the removal of public guarantees. Public guarantees seem to be associated with substantial moral hazard effects.
Original languageEnglish
Place of PublicationTilburg
PublisherEBC
Number of pages48
Volume2010-21S
Publication statusPublished - 2010

Publication series

NameEBC Discussion Paper
Volume2010-21S

Fingerprint

Natural experiment
Bank risk taking
Guarantee
Government guarantees
Loans
Interest rates
Credit
Screening
Z-score
Germany
Savings banks
Monitoring
Difference-in-differences
Moral hazard
Credit risk

Keywords

  • banking
  • public guarantees
  • credit risk
  • moral hazard

Cite this

Gropp, R., Grundl, C., & Guttler, A. (2010). The Impact of Public Guarantees on Bank Risk Taking: Evidence from a Natural Experiment. (EBC Discussion Paper; Vol. 2010-21S). Tilburg: EBC.
Gropp, R. ; Grundl, C. ; Guttler, A. / The Impact of Public Guarantees on Bank Risk Taking : Evidence from a Natural Experiment. Tilburg : EBC, 2010. (EBC Discussion Paper).
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Gropp, R, Grundl, C & Guttler, A 2010 'The Impact of Public Guarantees on Bank Risk Taking: Evidence from a Natural Experiment' EBC Discussion Paper, vol. 2010-21S, EBC, Tilburg.

The Impact of Public Guarantees on Bank Risk Taking : Evidence from a Natural Experiment. / Gropp, R.; Grundl, C.; Guttler, A.

Tilburg : EBC, 2010. (EBC Discussion Paper; Vol. 2010-21S).

Research output: Working paperDiscussion paperOther research output

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AB - In 2001, government guarantees for savings banks in Germany were removed following a law suit. We use this natural experiment to examine the effect of government guarantees on bank risk taking, using a large data set of matched bank/borrower information. The results suggest that banks whose government guarantee was removed reduced credit risk by cutting off the riskiest borrowers from credit. At the same time, the banks also increased interest rates on their remaining borrowers. The effects are economically large: the Z-Score of average borrowers increased by 7% and the average loan size declined by 13%. Remaining borrowers paid 57 basis points higher interest rates, despite their higher quality. Using a difference-in-differences approach we show that the effect is larger for banks that ex ante benefitted more from the guarantee. We show that both the credit quality of new customers improved (screening) and that the loans of existing riskier borrowers were less likely to be renewed (monitoring), after the removal of public guarantees. Public guarantees seem to be associated with substantial moral hazard effects.

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Gropp R, Grundl C, Guttler A. The Impact of Public Guarantees on Bank Risk Taking: Evidence from a Natural Experiment. Tilburg: EBC. 2010. (EBC Discussion Paper).