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Government guarantees and the risk-taking of financial institutions: evidence from a regulatory experiment

  • Christina Atanasova
  • Mingxin Li
  • Yevgeny MugermanEmail author
  • Mehrdad Rastan
Original Article
  • 21 Downloads

Abstract

The potential dark side of government guarantees, introduced to mitigate concerns about financial stability during economic downturns, is that they may create incentives for excessive risk-taking. In a low-interest rate environment, this effect may be even stronger as financial institutions try to “reach for yield”. In this paper, we use the 2008 introduction of unlimited deposit insurance for all credit unions in the province of British Columbia, Canada, to examine the effect of government guarantees on financial institutions’ earnings uncertainty. We find that the policy change resulted in an economically and statistically significant decrease in earnings uncertainty. In addition, although deposits grew following the policy change, lending did not increase and instead capitalization ratios improved. Overall, our results suggest that the provincial government guarantee boosted depositor confidence and increased the flow of funds to the insured financial institutions. We do not find support for the risk-taking hypothesis but instead show that risk management improved following the policy change. Finally, the effect of the policy change was stronger for smaller, more levered credit unions as well as those with fewer members and smaller market share.

Keywords

Risk-taking Deposit insurance Financial cooperatives Earnings volatility 

JEL Classification

G21 G28 L31 G22 

Notes

Acknowledgements

We thank the Financial Institutions Commission for providing the data. The paper is the opinion of the authors only and does not represent the views of the Financial Institutions Commission. We acknowledge helpful comments from Giorgio Caselli, Claudia Girardone, Jose Berrospide, Martin Cihak, Nadia Massoud, Jesus Sierra Jimenez, as well as the participants at IWFSAS, Vitoria and AFM, Auckland.

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Copyright information

© Springer Nature Limited 2019

Authors and Affiliations

  • Christina Atanasova
    • 1
  • Mingxin Li
    • 1
  • Yevgeny Mugerman
    • 2
    Email author
  • Mehrdad Rastan
    • 3
  1. 1.Beedie School of BusinessSimon Fraser UniversityBurnabyCanada
  2. 2.Graduate School of Business AdministrationBar-Ilan UniversityRamat GanIsrael
  3. 3.Financial Institutions Commission VancouverCanada

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