Banking Risks Around the World: The Implicit Safety Net Subsidy Approach

Abstract

The degree of risk taking by a bank is related to the size of the gross subsidy that has been extended to the bank by the safety net. This subsidy can be calculated by applying a technique that models deposit insurance as a put option on the bank's assets.

Laeven calculates gross safety net subsidies for a large sample of banks in 12 countries to assess the relationship between the risk-taking behavior of banks and certain bank characteristics. He finds that gross safety net subsidies are higher for banks that have concentrated ownership, that are affiliated with a business group, that are small, or that have high credit growth, and for banks in countries with low GDP per capita, high inflation, or poor quality and enforcement of the legal system. These findings suggest that the moral hazard behavior of a bank depends on its institutional environment and its corporate governance structure.

Laeven also presents a matrix that shows estimates of safety net subsidies for a range of given combinations of equity volatilities and equity-to-deposit ratios. These figures could be used as input to an early warning system for both individual and systemic banking problems.

This paper - a product of the Financial Sector Strategy and Policy Department - is part of a larger effort in the department to study the performance and risks of banks. The author may be contacted at [e-mail].