How Country and Safety-Net Characteristics Affect Bank Risk-Shifting

TLDR

Risk‑shifting occurs when creditors or guarantors face losses without adequate compensation. The study measures and compares how 56 countries’ authorities controlled bank risk‑shifting in the 1990s. Risk‑shifting is significant on average but varies widely across countries; deposit insurance can worsen it unless paired with loss‑control features, and it has adverse effects in low‑freedom, high‑corruption settings.

Abstract

Risk-shifting occurs when creditors or guarantors are exposed to loss without receiving adequate compensation. This paper seeks to measure and compare how well authorities in 56 countries controlled bank risk shifting during the 1990s. Although significant risk shifting occurs on average, substantial variation exists in the effectiveness of risk control across countries. We find that the tendency for explicit deposit insurance to exacerbate risk shifting is tempered by incorporating loss-control features such as risk-sensitive premiums, coverage limits, and coinsurance. Introducing explicit deposit insurance has had adverse effects in environments that are low in political and economic freedom and high in corruption.