Bank Risk-taking, Country Financial Capacity and Bank Bailouts in Crisis Periods: A Cross Country Analysis

This paper analyzes the impact of government bailout policies on the risk of the banking sector in OECD countries between 2005 and 2013. Consistent with previous literature, we verify that financial institutions with high bailout expectations assume higher risks than others do. We also find that, in normal times, rescue guarantees to large financial institutions distort competition in the sector and increase the risk of the unprotected institutions. Moreover, unprotected banks decrease their risk exposures faster than protected banks after the eruption of the 2007-2008 crisis, particularly in countries with deteriorated sovereign capacity to bailout banks. Taken together, these results indicate that a reduction in bailout probability decreases bank risk taking.