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Payout Restrictions and Bank Risk-Shifting
This paper studies the effects of regulatory payout restrictions on bank risk-shifting. Using policies imposed during the Covid-crisis on U.S. banks as a natural experiment and a high frequency differences-in-differences approach, we show that, when payouts are restricted, banks’ equity prices fall while their debt values appreciate. Moreover, banks that are ex-ante more exposed to the payout restrictions decrease risk-taking in lending relative to less exposed banks. Consistent with a risk-shifting channel, these effects revert once restrictions are lifted. These results indicate that ...
Discussion Paper
Do Payout Restrictions Reduce Bank Risk?
In June 2020, the Federal Reserve issued stringent payout restrictions for the largest banks in the United States as part of its policy response to the COVID-19 crisis. Similar curbs on share buybacks and dividend payments were adopted in other jurisdictions, including in the eurozone, the U.K., and Canada. Payout restrictions were aimed at enhancing banks’ resiliency amid heightened economic uncertainty and concerns about the risk of large losses. But besides being a tool to build capital buffers and preserve bank equity, payout restrictions may also prevent risk-shifting. This post, which ...
Working Paper
Risk-Shifting, Regulation, and Government Assistance
This paper examines an episode when policy response to a financial crisis effectively incentivized financial institutions to reallocate their portfolios toward safe assets. Following a shift to a regime of enhanced regulation and scaled-down public assistance during the savings and loan crisis in 1989, I find that thrifts with a high probability of failure increased their composition of safe assets relative to thrifts with a low probability of failure. The findings also show a shift to safe assets among stock thrifts relative to mutual thrifts, thereby providing evidence of risk-shifting from ...
Working Paper
Does Risk-Taking Increase or Decrease with Higher Interest Rates?
We present a framework that accounts for how interest rates affect risk-taking by borrowers indirectly, by changing the borrower’s demand for credit (investment size). We find that this borrowing demand effect runs counter to the direct borrowing rate effect, and risk-taking can increase or decrease with higher rates depending on the relative strength of these effects. We show that the borrowing rate effect dominates when the borrower’s share of project returns is increasing in investment, so risk-taking increases with interest rates. However, the borrowing demand effect dominates when ...
Working Paper
Why Are Banks Not Recapitalized During Crises?
I develop a model where the sovereign debt capacity depends on the capitalization of domestic banks. Low-capital banks optimally tilt their government bond portfolio toward domestic securities, linking their destiny to that of the sovereign. If the sovereign risk is sufficiently high, low-capital banks reduce private lending to further increase their holdings of domestic government bonds, lowering sovereign yields and supporting the home sovereign debt capacity. The model rationalizes, in the context of the eurozone periphery, the increase in domestic government bond holdings, the reduction ...