Government support to banks through the provision of explicit or implicit guarantees affects the willingness of banks to take on risk by reducing market discipline or by increasing charter value. We use an international sample of rated banks and find that government support is associated with more risk taking by banks. More importantly, we find that restricting banks’ range of activities ameliorates the link between government support and bank risk taking. We conclude that, in the presence of moral hazard induced by government support, reducing bank complexity strengthens market discipline.

We analyze how two types of recently used prudential policies affected the supply of credit in the United States. First, we test whether the U.S. bank stress tests had any impact on the supply of mortgage credit. We find that initiation of the Comprehensive Capital Analysis and Review (CCAR) stress tests in 2011 had a negative effect on the share of jumbo mortgage originations and approval rates at stress-tested banks, whereby banks with worse capital positions were impacted more negatively. Second, we analyze the impact of the 2013 Supervisory Guidance on Leveraged Lending and subsequent 2014 FAQ notice, which clarified expectations on the Guidance. We find that the institution-specific share of speculative-grade term-loan originations decreased notably at regulated banks after the FAQ notice, especially at banks with greater market share for such loans.

We use credit-arbitrage asset-backed commercial paper vehicles as a laboratory to empirically examine financial institutions’ motivations to take bad-tail systematic risk. By comparing the characteristics of global banks that sponsored credit-arbitrage vehicles prior to the global financial crisis to those that did not, we show that owner–manager agency problems, government safety nets, and government ownership of banks are associated with bad-tail systematic risk-taking. Although good governance is associated with less risk-taking on average, well-governed banks that also have a high ex ante expectation of being bailed out by the government take more risk. Lastly, we find mixed evidence that tougher bank capital regulation deters bad-tail risk-taking.