Risk-Shifting by Federally Insured Commercial Banks

Armen Hovakimian, Edward J. Kane

NBER Working Paper No. 5711
Issued in August 1996
NBER Program(s):   CF

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.

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Published: (Under new title: Changing Effectiveness of Capital Regulation at U.S. Commercial Banks, 1985-1994) Journal of Finance, Vol. 55 (February 2000): 451-461.

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