Journal of Financial Services Research

, Volume 23, Issue 3, pp 177-204

First online:

How Country and Safety-Net Characteristics Affect Bank Risk-Shifting

  • Armen HovakimianAffiliated withBaruch College
  • , Edward J. KaneAffiliated withFinance Department, Boston College
  • , Luc LaevenAffiliated withWorld Bank

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Risk-shifting occurs when creditors or guarantors are exposed to loss without receiving adequate compensation. This paper seeks to measure and compare how well authorities in 56 countries controlled bank risk shifting during the 1990s. Although significant risk-shifting occurs on average, substantial variation exists in the effectiveness of risk control across countries. We find that the tendency for explicit deposit insurance to exacerbate risk shifting is tempered by incorporating loss-control features such as risk-sensitive premiums, coverage limits, and coinsurance. Introducing explicit deposit insurance has had adverse effects in environments that are low in political and economic freedom and high in corruption.

deposit insurance regulatory forbearance moral hazard financial safety net risk shifting regulation.