Banks without Parachutes - Competitive Effects of Government Bail-out Policies

Lecture on the first SFB/TR 15 meeting, Gummersbach, July, 18 - 20, 2004The explicit or implicit protection of banks through government bail-out policies is a universal phenomenon. We analyze the competitive effects of such policies in two models with different degrees of transparency in the banking sector. Our main result is that the bail-out policy unambiguously leads to higher risk-taking at those banks that do not enjoy a bail-out guarantee. The reason is that the prospect of a bail-out induces the rotected bank to expand, thereby intensifying competition in the deposit market and depressing other banks’ margins. In contrast, the effects on the protected bank’s risk taking and on welfare depend on the transparency of the banking sector.