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Government Guarantees and Bank Risk Taking Incentives
Report

Government Guarantees and Bank Risk Taking Incentives

Markus Fischer, Christa Hainz, Jörg Rocholl and Sascha Steffen
CESifo Group Munich, 2014
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Editorial Rating

7

Qualities

  • Analytical
  • Innovative
  • Eye Opening

Recommendation

As central bankers and government officials consider removing the explicit and implicit financial guarantees they established in the heat of fiscal crises, Germany’s early 2000s experience with its Landesbanken offers some significant lessons. These state-owned banks subsequently had an outsized role in building the global asset-backed securities bubble that burst in 2008. getAbstract recommends this perceptive analysis from the Center for Economic Studies & Ifo Institute for the light it sheds on the unintended consequences of ending government guarantees.

Summary

In reacting to financial crunches, governments have provided guarantees to a broad range of financial institutions. These actions managed to stem public panic and have helped underwrite the recovery among developed economies. It’s unclear, however, what effects lifting these guarantees will have. Without state support, a bank experiences a higher cost of capital and lower overall profitability. That drop in its “franchise value” – “the present value of future profits” – spurs risk taking to shore up profits. But shareholders...

About the Authors

Markus Fischer teaches business administration at Goethe University Frankfurt. Christa Hainz is a senior economist at the Ifo Institute. Jörg Rocholl is the president of the European School of Management and Technology in Berlin, where Sascha Steffen is an associate professor.

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