Browsing by Subject "moral hazard"

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  • Mayes, David G. (2004)
    Suomen Pankin keskustelualoitteita 4/2004
    Published in Journal of Banking and Finance, Vol. 29, No. 1 (Special Issue), January 2005: 161-181
    In the light of the inequity of the way losses from bank insolvencies and their avoidance through intervention by the authorities have been distributed over creditors, depositors, owners and the population at large in transition and emerging economies, this paper explores a number of regulatory reforms that would alter the balance between seeking to avoid insolvency and lowering the costs of insolvency should it occur.In particular it considers whether a lex specialis for dealing with banks that are in trouble through prompt corrective action and if necessary resolving them if their net worth falls to zero, at little or no cost to the taxpayer can be applied in the institutional framework of transition and emerging economies. Key words: insolvency, banks, transition, emerging economies JEL classification numbers: K23, G21, O16, G28, E53
  • Kauko, Karlo (World Scientific, 2018)
    Singapore Economic Review 3
    Policy discussions are dominated by the view that governmental safety nets offered to banks cause moral hazard and encourage risk-taking. However, [Cordella, T and E Levy Yeyati (2003). Bank bailouts: moral hazard vs. value effect. Journal of Financial Intermediation, 12, 300–330.] proposed that government support offered during crises may increase bank franchise value, resulting in less risk-taking. This paper presents additional theoretical results on the franchise value effect. The franchise value effect can dominate over the moral hazard effect even when there are no specific crisis periods. The franchise value effect dominates if bank shareholders have a weak time preference and if the decision on the intensity of risk monitoring is a long-term choice.
  • Vihriälä, Vesa (1996)
    Suomen Pankin keskustelualoitteita 9/1996
    The paper analyzes bank loan supply in a simple value maximizing partial equilibrium framework.The focus is on the role of bank capital, capital regulation and the pricing of bank liabilities.The model is constructed so as to resemble the situation of the Finnish local banks in the late 1980s and the early 1990s, particularly with regard to capital regulation which changed subtantially during this period.While equity capital is assumed exogenous, the bank may choose the amount of subordinated debt which also counts as regulatory capital.The model shows that bank characteristics matter for loan supply, when the bank is penalized for bank failure (capital insufficiency relative to a regulatory requirement).When this penalty is positive, fair or excessive pricing (lemons premium) of bank liabilities makes bank lending depend positively on bank capital but underpricing results in a negative relationship.A negative relationship may also emerge if the bank anticipates "perverse" bank support policies ie. that capital insufficiency will be rewarded with transfers from the authorities.Thus both a credit crunch due to lack of capital and "excessive" risky lending due to moral hazard can obtain in a single model, depending on the circumstances.The precise nature of capital regulation is not important, provided a failure to meet the requirement is sufficiently penalized.The model suggests that the mutually exclusive hypotheses of credit crunch excessive lending due to moral hazard can be tested not only by examining the relationship between bank lending on the one hand and bank equity and bank costs on the other hand, but also by examining the relationship of subordinated debt with bank lending and the capital ratio. Keywords: bank lending, capital, capital regulation, moral hazard, credit crunch
  • Vauhkonen, Jukka (2009)
    Bank of Finland Research Discussion Papers 29/2009
    Published in Journal of Financial Services Research, Volume 41, Numbers 1-2, 2012: 37-49
    We consider the impact of mandatory information disclosure on bank safety in a spatial model of banking competition in which a bank s probability of success depends on the quality of its risk measurement and management systems. Under Basel II capital requirements, this quality is either fully or partially disclosed to market participants by the Pillar 3 disclosures. We show that, under stringent Pillar 3 disclosure requirements, banks equilibrium probability of success and total welfare may be higher under a simple Basel II standardized approach than under the more sophisticated internal ratings-based (IRB) approach.
  • Vihriälä, Vesa (1997)
    Suomen Pankki. E 7
    The study focuses on the role of deposit banks in the makings of the Finnish credit cycle of 1986-1995.A preliminary descriptive analysis suggests that banks' credit supply had a positive effect on credit growth in the boom period and a negative effect in the early 1990s.There are furthermore some indications that moral hazard of weak banks played a role in the expansion phase and that insuffient capital constrained lending later on, thus causing a credit crunch. A theoretical model set up here suggests that one should examine the effects of both bank capital and costs on lending and also look at the issuance of subordinated debt as a means of testing the moral hazard and credit crunch hypotheses. An empirical analysis of the behaviour of 483 cooperative and savings banks over the second half of the 1980s gives strong support to the moral hazard hypothesis.In particular, the aggregate credit supply of the savings banks would have been substantially less if their capital had been high enough to eliminate moral hazard incentives. By contrast, almost no evidence of a credit crunch induced by weak bank capital is found in an analysis of 313 cooperative and savings bank in 1991 and 1992.Instead the effects of borrower creditworthiness and credit demand are underlined. Keywords: credit crunch, moral hazard, capital regulation, banking crisis
  • Vauhkonen, Jukka (2003)
    Suomen Pankin keskustelualoitteita 13/2003
    In most countries, banks' equity holdings in firms that borrow from then are rather small.In light of the theoretical literature, this is somewhat surprising.For example, according to agency cost models, allowing banks to hold equity would seem to alleviate firms' asset substitution moral hazard problem associated with debt financing.This idea is formalised in John, John, and Saunders in a model where banks are modeled as passive investors and bank loans are the only source of outside finance for firms.In this paper, we argue that this alleged benefit of banks' equity holding is small or non-existent when banks are modeled explicitly as active monitors and firms have access also to market finance.Key words: banks' equity holdings, firms' capital structure, social welfare JEL classification numbers: D82, G32
  • Vihriälä, Vesa (1996)
    Suomen Pankin keskustelualoitteita 10/1996
    The paper examines the determination of bank lending during the Finnish credit boom of 1986-1990 with the data of 483 savings and cooperative banks.A particular objective is to establish whether bank behaviour is consistent with what is called moral hazard hypothesis, according to which banks expanded risky lending in part to benefit from underpricing of bank liabilities and/or anticipated bank support policies, which would reward capital insufficiency.The results strongly support the moral hazard hypothesis.Growth of lending was, ceteris paribus, negatively associated with bank capital and positively associated with bank costs.Also the behaviour of subordinated debt is consistent with the moral hazard hypothesis.The findings suggest that the cause of such behaviour was underpriced non-deposit liabilities rather than underpriced deposit insurance or anticipation at perverse bank policies.The perverse behaviour was much stronger among the savings banks than among the cooperative banks.According to calculations based on the estimation results, the growth rate of savings bank lending had been 1/3 smaller than the actual growth rate in 1986-1990 in the absence of moral hazard.In the case of the cooperative banks the estimated moral hazard effect is less than l/10 of the growth rate.Given the clear positive association of the rate of growth of lending during the boom period and the amount of non-performing assets later during the banking crisis, the disproportionary losses of the savings bank group are - in the light of this analysis - largely due to moral hazard.Consequently also most of the government expenditure on bank support appears to be caused by distorted incentives. Keywords: bank lending, moral hazard, deposit insurance, creditor protection, bank support
  • Karas, Alexei; Pyle, William; Schoors, Koen (2019)
    BOFIT Discussion Papers 10/2019
    Using evidence from Russia, we explore the effect of the introduction of deposit insurance on bank risk. Drawing on within-bank variation in the ratio of firm deposits to total household and firm deposits, so as to capture the magnitude of the decrease in market discipline after the introduction of deposit insurance, we demonstrate for private, domestic banks that larger declines in market discipline generate larger increases in traditional measures of risk. These results hold in a difference-in-difference setting in which state and foreign-owned banks, whose deposit insurance regime does not change, serve as a control.
  • Topi, Jukka (2003)
    Suomen Pankki. E 24
    This study discusses the effects of financial intermediation, banks' moral hazard and monitoring on monetary policy transmission in a simple model where borrowers are dependent on loans granted by banks with superior monitoring skills.As distinct from the prior literature on monetary policy transmission, this study does not regard banks' deposit funding as a reason for their special role in the monetary transmission.Instead, we focus on banks' role in monitoring their loan customers as part of financial intermediation and on the effects of monitoring on monetary policy. We find that when the intensity of monitoring is endogenous banks acting as financial intermediaries with moral hazard problems respond less to monetary policy in lending than nonintermediary lenders that only lend their own capital without moral hazard problems.We also find that in the model the lending response of intermediary banks to monetary policy depends on the ratio of their own capital to the volume of lending.The finding is fairly insensitive to the market structure of the banking sector.In the case of a monopoly bank, an increase in the bank's capital-to-loans ratio always weakens the transmission of monetary policy to bank lending.In the case of competitive banks, an increase in the capital-to-loans ratio weakens the transmission of monetary policy to aggregate bank lending, up to a critical level. Using a data set covering the Finnish banking sector in 1995-2000, we also offer some tentative empirical evidence that is broadly consistent with the model.Banks with higher capital ratios tend to respond less to changes in monetary policy.Our conclusion is that the outcome of the model might be helpful in explaining the heterogeneity of banks' responses to monetary policy, which frequently observed in the empirical literature. Keywords: monetary policy transmission, monitoring, moral hazard, bank lending channel
  • Suominen, Matti (1999)
    Suomen Pankin keskustelualoitteita 23/1999
    In this paper we study industry equilibrium and the effects of integration under the assumptions that 1) firms must use outside financing and 2) they face a moral hazard problem due to the possibility of taking excessive risks.These are typical features of banking and insurance, for instance.We examine an industry equilibrium where firms choose not to take excessive risks and compare this with the equilibrium in industries that do not have a moral hazard problem.We show that, as markets integrate, competition intensifies and prices fall in both types of industry. In markets with moral hazard there are relatively more exits, a smaller fall in prices and, contrary to the other case, the market value of the industry increases. Key words: industry equilibrium, outside financing, risk-taking behaviour, market integration
  • Niskanen, Mikko (2002)
    Suomen Pankin keskustelualoitteita; Bank of Finland. Discussion papers 17/2002
    We study the effects of investor protection on the availability of external finance, entrepreneurship, and creation of new firms in an equilibrium search model of private capital markets.In addition to search frictions, we examine contract frictions, specifically interim and ex post moral hazard problems stemming from entrepreneurs' possibilities to expropriate financiers.In our model, the government chooses the level of investor protection that determines the transferability of match surplus between entrepreneurs and financiers.The results indicate that anything that increases (decreases) entrepreneurship also increases (decreases) the creation of start-ups.The effect of investor protection on the creation of start-ups thus hinges on the relative importance of various search and contract frictions.Only when investor protection has a sufficiently large impact on the ex post moral hazard problem relative to the interim moral hazard does strengthening investor protection enhance start-up creation.We also find that search frictions dilute the beneficial effect of investor protection and that contract frictions modify the standard Hosios condition for efficiency. Key words: investor protection, start-up financing, private equity market, entrepreneurship, corporate finance JEL classification numbers: E50, G21, G24
  • Herrala, Risto (2000)
    Suomen Pankin keskustelualoitteita 3/2000
    We study the long standing issue of whether markets can supply banks with sufficient liquidity or whether markets should be complemented with a lender of last resort (LOLR).For this purpose, we develop an extended version of the recent model of Holmström and Tirole (1998) on the supply of liquidity to firms. H&Ts original model analyses liquidity supply to firms that are facing solvency shocks.We apply their framework to banking and extend the framework to admit the analysis of problems associated with transitory liquidity outflows, even absent any change in a bank's value.Our premise is that the scope for moral hazard may increase in connection with liquidity outflows.Moral hazard, which we interpret as the possibility of laxity in banks' monitoring of firms, may increase with liquidity outflows because banks need to increase their monitoring efforts in order to safeguard their own interests. The model illustrates many key aspects of the classical LOLR debate.The model shows how moral hazard limits of banks' ability to borrow from markets to cover liquidity outflows.It also predicts banks' demand for liquid reserves and the economies associated with centralization of reserves in a liquidity pool when the holding of liquid reserves entails opportunity costs.Finally, the model enables discussion of viable lending policies for the LOLR and contrast these with the 'Bagehotian principles', which are still widely used as benchmark criteria in evaluating LOLR operations. Key words: liquidity, lender of last resort, banking, central banking
  • Niinimäki, Juha-Pekka (2010)
    Bank of Finland Research Discussion Papers 22/2010
    This theoretical paper explores the effects of costly and non-costly collateral on moral hazard, when collateral value may fluctuate. Given that all collateral is costly, stochastic collateral will entail the same positive incentive effects as nonstochastic collateral, provided the variation in collateral value is modest. If it is large, the incentive effects are smaller under stochastic collateral. With non-costly collateral, stochastic collateral entails positive incentive effects or no effects, if the variation in collateral value is modest. If it is large, the incentive effects may be positive or negative. Thus, collateral can increase moral hazard. The findings are related to the topical subprime crisis and the fluctuating value of real estate collateral.?
  • Halme, Liisa (1996)
    Suomen Pankin keskustelualoitteita 27/1996
    Keskustelualoite on ensimmäinen osa laajempaa projektia, jossa arvioidaan pankkilainsäädännön muutostarpeita pankkikriisin kokemusten valossa.Keskustelualoitteessa tarkastellaan Suomen pankkilainsäädännön kehitystä taloustieteessä sääntelyn vaikutuksista esitettyjä näkemyksiä vastaan. Taloustieteen näkemyksistä tarkastellaan sääntelyn ja valvonnan talousteoreettisia perusteita sekä sääntelyn ei-toivottuja seurauksia, joista keskeiseksi nostetaan moraalikato ja siihen liittyvä piittaamaton riskinotto.Lisäksi kuvataan talous- ja oikeustaloustieteen näkemyksiä a) lainsäännöksistä kannustimina saavuttaa lainsäätäjän tavoitteet, b) agentista eli pankista normien noudattajana ja normeihin vaikuttajana sekä c) keinoista lisätä lainsäännösten toivottuja kannustinvaikutuksia. Pankkilainsäädännön päätavoitteet ovat linjassa taloustieteessä esitettyjen näkemysten kanssa.Tavoitteisiin pääsemiseksi valituissa keinoissa sen sijaan ei ole vältytty niiltä haittavaikutuksilta, joiden takia osa taloustieteilijöistä ehdottaa kokonaanluopumista sääntelystä.Lain valmistelussa on nähtävissä varsin vähän arviointia, miten valvojan käyttäytyrrunen vaikuttaa säännösten noudattamiseen. Tämän vuosisadan alun lainsäädännössä tavoitteet ja keinot olivat sopusoinnussa keskenään.Ristiriidassa ne olivat 1970 alusta voimaan tulleessa lainsäädännössä. Toimintaoikeuksia lisättiin ja vastapainona korostettiin vakavaraisuuden tärkeyttä. Vakavaraisuusvaatimuksia kuitenkin alennettiin.Säästöpankkien sallittiin toimia liikepankkimaisesti ilman riittäviä vakavaraisuuspuskureita. 1980-luvun lainvalmistelun keskeisin heikkous oli valmistelun hitaus, perusteluiden kapea-alaisuus, muodollisen yksimielisyyden hakeminen sekä säännöstön poikkearninen kansainvälisistä vaatimuksista.Kanteiden nostamista koskevien määräaikojen lyhentäminen eri aikaan eri pankkiryhmien osalta on myöhemmin ratkaisevasti vaikuttanut eri pankkiryhmien johdon tosiasialliseen taloudelliseen vastuuseen. Pankkien rooli lainvalmistelussa on ollut vahva.Viranomaiset näyttävät hyväksyneen pankkien keskeisen roolin, mistä osoituksena voidaan pitää mm. sitä, että pankit ovat voineet itse laatia ehdotuksia itseään koskeviksi lainsäännöksiksi. Talletussuojan moraalikatoa lisäävien vaikutusten vähentämiseksi on muodollista talletussuojaa olennaisempaa, miten laaja on tosiasiallinen velkojien, jopa omistajien suoja.Mikäli kattavaa tosiasiallista suojaa pidetään välttämättömänä, sen vastapainona tulisi olla tiukentuneet omistajien vastuuta korostavat säännökset. Pankkivalvonnan keskeisenä tehtävänä tulisi olla sen varmistaminen, että vastuu pankkien toiminnoista ja toiminnasta annettavien tietojen luotettavuudesta on pankin johdolla ja omistajilla. Asiasanat: Pankkisääntely, pankkivalvonta, moraalikato, rationaalinen agentti
  • Peresetsky, A.A.; Karminsky, A.M.; Golovan, S.V. (2007)
    BOFIT Discussion Papers 2/2007
    Published in Russian in Economics and Mathematical Methods (ЭКОНОМИКА И МАТЕМАТИЧЕСКИЕ МЕТОДЫ), v. 43, n.1, 2007, pp. 3-15 as "Deposit interest rates in the Russian banks, market discipline and deposit insurance system" (ПРОЦЕНТНЫЕ СТАВКИ РОССИЙСКИХ БАНКОВ. РЫНОЧНАЯ ДИСЦИПЛИНА И СТРАХОВАНИЕ ДЕПОЗИТОВ)
    This paper examines the extent to which the observed diversity of private deposit interest rates in Russia is explained by bank financial indicators.We also test for whether the introduction of the bank deposit insurance scheme in 2005 affected deposit interest rates.Our results suggest market discipline in the Russian banking system involves Russian depositors demanding higher deposit interest rates from banks with risky financial policies.This discipline seems stronger than in developed countries.Our study suggests also that the risks taken by banks increased after introducing the deposit insurance.Key words: banking, deposit interest rates, moral hazard, deposit insurance, Russia JEL codes: D43, E53, G21, P34
  • Hasan, Iftekhar; Hoi, Chun-Keung (Stan); Wu, Qiang; Zhang, Hao (2015)
    Bank of Finland Research Discussion Papers 21/2015
    Published in Journal of Financial and Quantitative Analysis, 52, 3, 2017: 1017-1047
    We find that firms headquartered in U.S. counties with higher levels of social capital incur lower bank loan spreads. This finding is robust to using organ donation as an alternative social-capital measure and incremental to the effects of religiosity, corporate social responsibility, and tax avoidance. We identify the causal relation using companies with a social-capital-changing headquarter relocation. We also find that high-social-capital firms face loosened nonprice loan terms, incur lower at-issue bond spreads, and prefer bonds over loans. We conclude that debt holders perceive social capital as providing environmental pressure constraining opportunistic firm behaviors in debt contracting.
  • Lucchetta, Marcella; Moretto, Michele; Parigi, Bruno M. (2018)
    Bank of Finland Research Discussion Papers 2/2018
    We show that the impact of government bailouts (liquidity injections) on a representative bank’s risk taking depends on the level of systematic risk of its loans portfolio. In a model where bank’s output follows a geometric Brownian motion and the government guarantees bank’s liabilities, we show first that more generous bailouts may or may not induce banks to take on more risk depending on the level of systematic risk; if systematic risk is high (low), a more generous bailout decreases (increases) bank’s risk taking. Second, the optimal liquidity policy itself depends on systematic risk. Third, the relationship between bailouts and bank’s risk taking is not monotonic. When systematic risk is low, the optimal liquidity policy is loose and more generous bailouts induce banks to take on more risk. If systematic risk is high and the optimal liquidity policy is tight, less generous bailouts induce banks to take on less risk. However, when high systematic risk makes a very tight liquidity policy optimal, a less generous bailout could increase bank’s risk taking. While in this model there is only one representative bank, in an economy with many banks, a higher level of systematic risk could also be a source of systemic risk if a tighter liquidity policy induces correlated risk taking choices by banks.
  • Vihriälä, Vesa (1996)
    Suomen Pankin keskustelualoitteita 8/1996
    The paper discusses the possibility that the workings of the financial system contributed the boom-bust cycle in the Finnish credit market since the mid-1980s.We begin with a review of the most prominent theoretical arguments about the role of "financial factors".Also the main findings of a vast empirical literature are summed up.This is followed by a description of the salient features of the Finnish credit cycle and the associated banking crisis.The evolution of credit stocks and interest rates are then analyzed on a relatively high level of aggregation from the perspective of the theoretical arguments discussed.The main conclusions are: First, changes in the balance sheets of firms and households very likely contributed to both the rapid growth of credit in the late 1980s and its subsequent steep contraction.Second, the observations are also consistent with the conjecture that supply of bank credit very likely increased in the late 1980s and contracted in the early 1990 relative to other sources of credit.Third, some differences observed in the behaviour of different bank groups suggest that moral hazard related to underpriced bank liabilities may have contributed to the growth of lending in the boom period, and problems with capital adequacy may have constrained bank lending in the early 1990s.Stylized facts are consistent with these conjectures.However, to reliably infer about these moral hazard and credit crunch hypotheses, in-depth analysis of bank behaviour with micro data is required. Similarily, ascertaining the role of borrower balance sheets requires analysis of borrowers of different characteristics. Keywords: credit cycle, financial factors, lending policies, moral hazard, credit crunch