Research Discussion Papers, Bank of Finland
Credit Growth and Moral Hazard. An Empirical Study of the Causes of Credit Expansion by the Finnish Local Banks in 1986–1990
Abstract: The paper examines the determination of bank lending
during the Finnish credit boom of 1986–1990 with the data of 483 savings
and cooperative banks. A particular objective is to establish whether bank
behaviour is consistent with what is called moral hazard hypothesis,
according to which banks expanded risky lending in part to benefit from
underpricing of bank liabilities and/or anticipated bank support policies,
which would reward capital insufficiency. The results strongly support the
moral hazard hypothesis. Growth of lending was, ceteris paribus, negatively
associated with bank capital and positively associated with bank costs.
Also the behaviour of subordinated debt is consistent with the moral hazard
hypothesis. The findings suggest that the cause of such behaviour was
underpriced non-deposit liabilities rather than underpriced deposit
insurance or anticipation at perverse bank policies. The perverse behaviour
was much stronger among the savings banks than among the cooperative banks.
According to calculations based on the estimation results, the growth rate
of savings bank lending had been 1/3 smaller than the actual growth rate in
1986–1990 in the absence of moral hazard. In the case of the cooperative
banks the estimated moral hazard effect is less than 1/10 of the growth
rate. Given the clear positive association of the rate of growth of lending
during the boom period and the amount of non-performing assets later during
the banking crisis, the disproportionary losses of the savings bank group
are — in the light of this analysis — largely due to moral hazard.
Consequently also most of the government expenditure on bank support
appears to be caused by distorted incentives.
Keywords: bank lending; moral hazard; deposit insurance; creditor protection; bank support; (follow links to similar papers)
56 pages, April 4, 1996
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