Unintended Consequences of Crisis Interventions for Financial Stability

• Applicant: Professor Dr. Sascha Steffen
• Subject Area: Accounting and Finance
• Term: from 2017 to 2020
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 348964002

The goal of our research proposal is to empirically investigate the unintended consequences of crisis interventions for financial stability. Since the beginning of the global financial crisis in 2007, governments and central banks around the world have implemented a wide range of support measures in an attempt to both stabilize the financial sector and ensure real sector lending. While short-term financial stability may partly be attributed to these interventions, our understanding of the long-term impact on incentives and expectations is still limited. With this proposal, we want to contribute to our understanding of the complex implications of crisis interventions for financial stability. The recent European financial and sovereign debt crisis is an ideal laboratory for this investigation. We will build a novel and comprehensive dataset of crisis interventions by European governments and the European Central bank over the 2007 to 2013 period. Combining the dataset with micro-level data on portfolio choices allows us to accurately track down how intervention measures influence decision taking of financial institutions. We address the following research questions: First, did weak European governments delay recapitalizations for distressed banks and thereby create additional risks for the financial system by allowing de facto insolvent banks to gamble for resurrection? While almost all European governments supported their banking sectors from the onset of the financial crisis in 2007, type and scope of interventions varied considerably across countries. We investigate the differential impact of these interventions on bank decisions in the loan making process using loan-level data. Second, did the European crises management lead to significant changes in perceptions of shareholders regarding the likelihood of future bailouts for systemically important banks? Using an asset-pricing approach, we want to quantify funding advantages with respect to equity cost of capital arising from implicit government guarantees. Importantly, we want to understand how expectations were impacted by actual interventions, regulatory changes and the creation of the Banking Union.Third, did the accommodative monetary policy and crisis interventions of the ECB lead to risk-shifting behavior in other parts of the financial system? Among others, the prolonged period of low interest rates has significantly reduced reinvestment returns in the insurance sector. We want to investigate how this has affected risk-taking incentives of insurers. As such, this project is a first attempt to contribute the current debate on financial stability and the design of the financial system by extending the discussion to the insurance sector.

• DFG Programme: Research Grants
• International Connection: USA
• Cooperation Partner: Professor Viral V. Acharya, Ph.D.