Monday, October 3, 2011

What happens when we bail out banks who take on too much risk?

New paper by Ran Duchin and Denis Sosyura finds that we get more risk:

after the bailout, bailed banks approve riskier loans and shift investment portfolios toward riskier securities.

As if this weren't bad enough, the shift to risk occurs within the same asset class so has little effect on the capitalization ratios watched by regulators to make sure that banks aren't taking on more risk. We are left with a most unhappy conclusion:

...the net effect is a significant increase in systemic risk and the probability of distress due to the higher risk of bank assets.

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