We present a banking model with imperfect competition in which borrowers’ access to credit is improved when banks are able to transfer credit risks. However, the market for credit risk transfer (CRT) works smoothly only if the quality of loans is public information. If the quality of loans is private information, banks have an incentive to grant unprofitable loans that are then transferred to other parties, leading to an increase in aggregate risk. Higher competition increases welfare in the presence of CRT with public information. In contrast, welfare eventually decreases for high levels of competition in the presence CRT with private information due to the expansion of unprofitable loans. This finding coincides with the decrease in credit quality observed during the late years of the credit boom preceding the subprime crisis.

We analyze the competitive effects of government bail-out policies in two models with different degrees of transparency in the banking sector. Our main result is that bail-outs lead to higher risk-taking among the protected bank’s competitors, independently of transparency. The reason is that the prospect of a bail-out induces the protected bank to expand, which intensifies competition in the deposit market, depresses other banks’ margins, and thereby increases risk-taking incentives. Contrary to conventional wisdom, protected banks may take lower risks when transparency in the banking sector is low and the deposit supply is sufficiently elastic.

Abstract We analyze the relationship between asset price bubbles and systemic risk, using bank-level data covering almost 30 years. Banks’ systemic risk already rises during a bubble’s buildup and even more so during its bust. The increase in risk strongly differs across banks and by bubble. It depends on bank characteristics (especially bank size) and bubble characteristics and can become very large: in a median real estate bust, systemic risk increases by almost 70% of the median for banks with unfavorable characteristics. These results emphasize the importance of bank-level factors in the buildup of financial fragility during bubble episodes. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

We analyze the reaction of stock returns and CDS spreads of banks from Europe and the United States to four major regulatory reforms in the aftermath of the subprime crisis, employing an event study analysis. In contrast to the public perception that nothing has happened, we find that financial markets indeed reacted to the structural reforms enacted at the national level. All reforms succeeded in reducing bail-out expectations, especially for systemic banks. However, banks’ profitability was also affected, showing up in lower equity returns. The strongest effects were found for the Dodd-Frank Act (especially the Volcker rule), whereas market reactions to the German restructuring law were small.