Financial crisis, liquidity infusion and risk-taking: The case of Canadian banks

We examine the effects of government liquidity infusion on the risk-taking behavior of Canadian banks and find that banks that received government financial assistance subsequently experienced a decrease in risk. The reduction in risk is induced by a shift from non-interest income-related activities to more traditional interest income-generating activities. After controlling for bank-specific risk factors, we find that while the liquidity infusion has made the banks more safe, higher amounts of funds received appears to induce higher investments in non-interest income-related activities. Further analysis aimed at disentangling the effects of the financial crisis from those of the liquidity infusion using observations of a control sample of banks that did not receive government support shows that risk taking by the focal banks in the aftermath of the financial crisis is significantly lower than that of the control sample. We argue that the stringent regulatory regime (involving high capital standards, tight mortgage market regulations, lower leverage ratio requirements and close supervision of banks) and the need to preserve rent seem to account for the risk-taking behavior of the banks.