Finance Finance News Govt guarantees to banks during GFC encouraged risk taking

Govt guarantees to banks during GFC encouraged risk taking

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The global financial crisis prompted governments around the world to guarantee their country’s banks to protect against collapse.

But a new study of more than 2,200 banks around the world showed that rather than prompt lending, government guarantees encouraged banks to take more risks but lend less.

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In yet to be published research, Dulani Jayasuriya, a Phd candidate in finance at the National University of Singapore obtained data from central banks and financial authorities in 78 countries spanning from 2001 to 2011.

Ms Jayasuriya found that instead of lending more money because the banks were effectively underwritten by the government, the banks took more risks.

“The surprising find is usually when you give money to these banks you expect them to reduce their risk.

“But what they actually do is they increase their risk taking and they reduce their lending,” Ms Jayasuriya told the ABC.

The study found that private and state banks with a government guarantee lent less money while foreign banks lent more.

In response to the financial meltdown, many governments guaranteed bank deposits or directly bailed out banks including in the United States, United Kingdom and Australia.

Ms Jayasuriya said banks tended to hold onto the cash they got from government to protect against future losses.

She said her study found that government guarantees for banks increased moral hazard especially for “too big to fail” banks – banks considered crucial to the stability of a banking system.

“Basically it’s like mum and dad will take care of you,” and you don’t have to take personal responsibility, she said.

Ms Jayasuriya said that “too big to fail” banks needed higher capital reserves to protect them against loan losses, a key recommendation of Australia’s Murray Financial System Inquiry.

However, she said Australian banks fared well in the study.