Bank Risk Taking and Liquidity Creation Following Regulatory Interventions and Capital Support

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Abstract
During times of bank distress, authorities often engage in regulatory interventions and capital support in order to reduce bank risk and calm financial markets. A potential unintended effect of such actions is that they may also reduce the liquidity created by banks, with possible adverse consequences for the economy as a whole. This paper investigates the effects of regulatory interventions and capital support on bank risk taking and liquidity creation over both the short run (one-year horizon) and long run (five-year horizon) using a unique dataset of German universal banks over the period 1999-2009. Our main findings are that regulatory interventions and capital support are associated with reductions in both risk taking and liquidity creation in the short term and long term. Thus, both types of actions have both intended and unintended consequences.

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