The real effects of bank public guarantees
Final Report Abstract
In this project, we study the role of government's safety nets for the banking sector using different settings. In all these projects, we spend substantial effort to ensure a causal estimation of the potential effects. Therefore, in addition to investigating the theoretical literature, we invested extensively in data collection and preparation, as our objectives were best met by undertaking empirical studies. The four papers written as part of this project examine the role of explicit government guarantees, implicit expectations of government support, and regulatory forbearance on banks, in different sectors of the real economy. We find that public guarantees alter banks' capital allocation decisions and reduce allocative efficiency by incentivizing banks to provide funding to unproductive firms and keeping them in the market for too long. We also show that regulatory forbearance on distressed banks during banking crises can mute the cleansing effects of recessions and hence slow down productivity growth and hence the recovery process in the medium to long run after recessions. Furthermore, we find that public intervention in the mortgage sector distorts the supply of mortgages, and hence exacerbates housing boom-bust cycles. Finally, we find that government’s control of banks can potentially create distortions in the electoral process by facilitating electoral lending, i.e. increased supply of loans in the run-up to local elections. We presented our results, in the meetings of the American Finance Association, European Finance Association, and Financial Intermediation Research Society, among others. Furthermore, Halle Institute for Economic Research (IWH) published the results of one of the papers as a policy note that was extensively covered by the German media.
Publications
- Electoral Lending - The Case of German Savings Banks, IWH Online 11/2015
Gropp, R., Saadi, V.
- (2016) Mortgage Supply and the US Housing Boom. SAFE working paper series ; No. 155
Saadi, V.
- (2016) Public Bank Guarantees and Allocative Efficiency, IWH Working Paper 2015/7
Gropp, R., Guettler, A., Saadi, V.
(See online at https://doi.org/10.2139/ssrn.2889304) - The Cleansing Effect of Banking Crises, Feb 2018, PDF: 52 S.
Gropp, R., Rocholl, J., Saadi, V.
