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IMF Economic Review

, Volume 66, Issue 1, pp 116–143 | Cite as

Government Guarantees, Transparency, and Bank Risk Taking

  • Tito Cordella
  • Giovanni Dell’Ariccia
  • Robert Marquez
Research Article

Abstract

We present a model of bank risk taking and government guarantees. Levered banks take excessive risk as their actions are not fully priced at the margin by debt holders. The impact of government guarantees on bank risk taking depends critically on the portion of bank investors that can observe bank behavior and hence price debt at the margin. Greater guarantees increase risk taking (moral hazard) when informed investors hold a sufficiently large fraction of liabilities. But, otherwise, they reduce risk taking by increasing the profits of the bank (franchise value effect). The results extend to the case in which information disclosure and, thus, the portion of informed investors is endogenous but costly. The model also shows that, when bank capital is endogenous, public guarantees lead unequivocally to an increase in bank leverage and an associated increase in risk taking. The analysis points to a complex relationship between prudential policy and the institutional framework governing bank resolution and bailouts.

JEL Classification

G1 G21 G28 

Supplementary material

41308_2018_49_MOESM1_ESM.doc (58 kb)
Supplementary material 1 (doc 58 KB)
41308_2018_49_MOESM2_ESM.xlsx (210 kb)
Supplementary material 2 (xlsx 210 KB)

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Copyright information

© International Monetary Fund 2018

Authors and Affiliations

  • Tito Cordella
    • 1
  • Giovanni Dell’Ariccia
    • 2
  • Robert Marquez
    • 3
  1. 1.The World BankWashingtonUSA
  2. 2.International Monetary Fund and CEPRWashingtonUSA
  3. 3.University of California, DavisDavisUSA

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