Friday, March 22, 2013

Bank Risk Taking during the New Deal

A recent working paper (gated), "Does “Skin in the Game” Reduce Risk Taking? Leverage, Liability and the Long-Run Consequences of New Deal Banking Reforms," by Kris James Mitchener and Gary Richardson examines moral hazard in lending. Essentially, New Deal regulations required bankers to take on some of the risk of the loans they made. From the abstract:
In states with contingent liability, banks used less leverage and converted each dollar of capital into fewer loans, and thus could survive larger loan losses (as a fraction of their portfolio) than banks in limited liability states. In states with limited liability, banks took on more leverage and risk, particularly in states that required banks with limited liability to join the Federal Deposit Insurance Corporation.

Requiring 'skin in the game' appears to reduce risk taking with other people's money.

1 comment:

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