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Risk-Shifting by Federally Insured Commercial Banks

Author

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  • Armen Hovakimian
  • Edward J. Kane

Abstract

Mispriced and misadministered deposit insurance imparts risk-shifting incentives to U.S. banks. Regulators are expected to monitor and discipline increases in bank risk exposure that would transfer wealth from the FDIC to bank stockholders. This paper assesses the success regulators had in controlling risk-shifting by U.S. banks during 1985-1994. In contrast to single-equation estimates developed from the option model by others, our simultaneous-equation evidence indicates that regulators failed to prevent large U.S. banks from shifting risk to the FDIC. Moreover, at the margin, banks that are undercapitalized shifted risk more effectively than other sample banks.

Suggested Citation

  • Armen Hovakimian & Edward J. Kane, 1996. "Risk-Shifting by Federally Insured Commercial Banks," NBER Working Papers 5711, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:5711
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    References listed on IDEAS

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    1. Edward J. Kane, 1987. "No Room for Weak Links in the Chain of Deposit Insurance Reform," NBER Working Papers 2317, National Bureau of Economic Research, Inc.
    2. Saunders, Anthony & Strock, Elizabeth & Travlos, Nickolaos G, 1990. "Ownership Structure, Deregulation, and Bank Risk Taking," Journal of Finance, American Finance Association, vol. 45(2), pages 643-654, June.
    3. Mark J. Flannery, 1982. "Deposit insurance creates a need for bank regulation," Business Review, Federal Reserve Bank of Philadelphia, issue Jan/Feb, pages 17-31.
    4. Goodman, Laurie S. & Santomero, Anthony M., 1986. "Variable-rate deposit insurance: A re-examination," Journal of Banking & Finance, Elsevier, vol. 10(2), pages 203-218, June.
    5. David Pyle, 1984. "Deregulation and deposit insurance reform," Economic Review, Federal Reserve Bank of San Francisco, issue Spr, pages 5-15.
    6. Gorton, Gary & Rosen, Richard, 1995. "Corporate Control, Portfolio Choice, and the Decline of Banking," Journal of Finance, American Finance Association, vol. 50(5), pages 1377-1420, December.
    7. Cooperstein Richard L. & Pennacchi George G. & Redburn F. Stevens, 1995. "The Aggregate Cost of Deposit Insurance: A Multiperiod Analysis," Journal of Financial Intermediation, Elsevier, vol. 4(3), pages 242-271, July.
    8. Duan, Jin-Chuan & Moreau, Arthur F. & Sealey, C. W., 1992. "Fixed-rate deposit insurance and risk-shifting behavior at commercial banks," Journal of Banking & Finance, Elsevier, vol. 16(4), pages 715-742, August.
    9. Buser, Stephen A & Chen, Andrew H & Kane, Edward J, 1981. "Federal Deposit Insurance, Regulatory Policy, and Optimal Bank Capital," Journal of Finance, American Finance Association, vol. 36(1), pages 51-60, March.
    10. Pyle, David H., 1986. "Capital regulation and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 10(2), pages 189-201, June.
    11. Ronn, Ehud I & Verma, Avinash K, 1986. "Pricing Risk-Adjusted Deposit Insurance: An Option-Based Model," Journal of Finance, American Finance Association, vol. 41(4), pages 871-895, September.
    12. Kane, Edward J., 1986. "Appearance and reality in deposit insurance: The case for reform," Journal of Banking & Finance, Elsevier, vol. 10(2), pages 175-188, June.
    13. Allen, Linda & Saunders, Anthony, 1993. "Forbearance and valuation of deposit insurance as a callable put," Journal of Banking & Finance, Elsevier, vol. 17(4), pages 629-643, June.
    14. Pennacchi, George G, 1987. "A Reexamination of the Over- (or Under-) Pricing of Deposit Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(3), pages 340-360, August.
    15. Marcus, Alan J & Shaked, Israel, 1984. "The Valuation of FDIC Deposit Insurance Using Option-pricing Estimates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(4), pages 446-460, November.
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    Citations

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    Cited by:

    1. Svensson, L-E-O, 1996. "Price Level Targeting vs Inflation Targeting : A free Lunch?," Papers 614, Stockholm - International Economic Studies.
    2. Vihriälä, Vesa, 1997. "Banks and the Finnish credit cycle 1986-1995," Scientific Monographs, Bank of Finland, number 1997_007.
    3. Tomislav Galac, 2005. "Does Croatia Need Risk-Based Deposit Insurance Premia?," Surveys 10, The Croatian National Bank, Croatia.
    4. Brock, Philip L., 1998. "Financial safety nets and incentive structures in Latin America," Policy Research Working Paper Series 1993, The World Bank.
    5. Bednarek, Peter & Dinger, Valeriya & Kaat, Daniel Marcel te & Westernhagen, Natalja von, 2021. "To whom do banks channel central bank funds?," Journal of Banking & Finance, Elsevier, vol. 128(C).
    6. Kane, Edward J., 1997. "Making bank risk shifting more transparent," Pacific-Basin Finance Journal, Elsevier, vol. 5(2), pages 143-156, June.
    7. repec:zbw:bofism:1997_007 is not listed on IDEAS
    8. Angelos Kanas & Panagiotis D. Zervopoulos, 2020. "Systemic risk-shifting in U.S. commercial banking," Review of Quantitative Finance and Accounting, Springer, vol. 54(2), pages 517-539, February.
    9. Ho, Chia-Ling & Lai, Gene C. & Lee, Jin-Ping, 2014. "Financial reform and the adequacy of deposit insurance fund: Lessons from Taiwanese experience," International Review of Economics & Finance, Elsevier, vol. 30(C), pages 57-77.
    10. Bednarek, Peter & Dinger, Valeriya & te Kaat, Daniel Marcel & von Westernhagen, Natalja, 2020. "Central bank funding and credit risk-taking," Discussion Papers 36/2020, Deutsche Bundesbank.
    11. Vihriälä, Vesa, 1997. "Banks and the Finnish credit cycle 1986-1995," Bank of Finland Scientific Monographs, Bank of Finland, volume 0, number sm1997_007, July.

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    More about this item

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • K2 - Law and Economics - - Regulation and Business Law

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