During the financial crisis, central banks, finance ministries, and legislatures across the globe put in place bank rescue packages for the most part financed by public funds. Have these unprecedented recapitalisations at public expense resulted in a reduction of risk in banks' loan books? Bank for International Settlements Working Paper No 383, "
Public Recapitalisations and Bank Risk: Evidence from Loan Spreads and Leverage," attempts to answer this very question in a way not tried before and using hard data and meaningful analysis.
In its paper, BIS uses as the subject of its analysis the most traditional types of financial intermediation activity, bank lending, to answer whether "the public rescue operations contribute to a reduction of risk in banks’ loan books in the years when they were granted and the years that followed? Have they helped in making institutions with risky lending activities safer?" Setting it apart from other similar studies, BIS approaches their analysis armed with two datasets, bank financial statements and individual syndicated loan transactions for the period from 2000 to 2010. These two datasets for a sample of large internationally active banks (87 in total after controlling for mergers acquisitions and missing data, approximately half of rescued banks) were then combined with information on bank rescue measures to analyse the relationship between bank bailouts and risk, and further allowing for double causality. BIS chose to focus on the market for syndicated loans because it represents a relatively significant component of banks’ total portfolio of commercial and industrial loans. In addition, the available information on individual loan transactions makes the syndicated loan market a good laboratory for analyzing bank risk with micro data.
So, have bailouts made banks less risky? According to the BIS study, the answer is "no." The riskiness of rescued banks’ syndicated lending appears to be significantly higher than that of non rescued banks. Although the riskiness of loan signings started diminishing across the board in 2009, BIS did not find consistent evidence that rescued banks reduced their risk relatively more than non rescued banks during the crisis. BIS acknowledges that there could be more than one reason for this, or even a combination of reasons.
Rescued banks may either be erring in risk management or consciously taking advantage of the implicit bailout guarantee. It could also be that rescued banks’ inefficiency in providing loans at competitive spreads is compounded by the higher funding costs that they have been facing themselves during the crisis.
To ensure they were drawing the right conclusions from the data and analysis, BIS subjected their analysis to a number of different crisis windows, to ascertain if and how the findings change during various episodes of the crisis. They found that the different crisis windows yielded the same results.
We experimented with a number of different crisis windows, to ascertain if and how our main findings change during various episodes of the crisis. To be sure, the period 2008-2009 comprised the most severe financial turmoil, which subsequently became protracted with the onset of the European sovereign debt crisis in 2010. This explains why we initially chose the period 2008-2010 as our crisis window. When we use 2008-2009 as the crisis window, the results are essentially unchanged: before the crisis, rescued banks took on higher risks than non rescued banks, and with the advent of the crisis they did not reduce their risk by more than non rescued banks.
The BIS study provides a clearer picture, if not the entire picture, of the effect of the bank bailouts on risk taking. Given the lack of meaningful reduction in rescued banks’ risk relative to non rescued institutions revealed by the BIS study, governments and central banks now have some basis on which think long and hard about future bailouts.