TAILIEUCHUNG - The Effect of TARP on Bank Risk-Taking Lamont Black and Lieu Hazelwood

While the United States struggles to develop a national infrastructure investment plan, the European Union has been operating a transna- tional, publically chartered infrastructure bank for longer than half a century. Founded in 1957, the European Investment Bank funds criti- cal projects throughout Europe and in developing nations worldwide to the tune of tens of billions of dollars every year. The bank is capitalized by funds from its 27 member states but also raises a large portion of its capital from issuing bonds. These funds are used to offer low-interest, long-term loans to both public and private entities, as well as loan guarantees. | Board of Governors of the Federal Reserve System International Finance Discussion IFDP 1043 March 2012 The Effect of TARP on Bank Risk-Taking Lamont Black and Lieu Hazelwood NOTE International Finance Discussion Papers are preliminary materials circulated to stimulate discussion and critical comment. References to International Finance Discussion Papers other than an acknowledgment that the writer has had access to unpublished material should be cleared with the author or authors. Recent IFDPs are available on the Web at pubs ifdp . This paper can be downloaded without charge from Social Science Research Network electronic library at . The Effect of TARP on Bank Risk-Taking Lamont Black and Lieu Hazelwood ABSTRACT One of the largest responses of the . government to the recent financial crisis was the Troubled Asset Relief Program TARP . TARP was originally intended to stabilize the financial sector through the increased capitalization of banks. However recipients of TARP funds were then encouraged to make additional loans despite increased borrower risk. In this paper we consider the effect of the TARP capital injections on bank risktaking by analyzing the risk ratings of banks commercial loan originations during the crisis. The results indicate that relative to non-TARP banks the risk of loan originations increased at large TARP banks but decreased at small TARP banks. Interest spreads and loan levels also moved in different directions for large and small banks. For large banks the increase in risk-taking without an increase in lending is suggestive of moral hazard due to government ownership. These results may also be due to the conflicting goals of the TARP program for bank capitalization and bank lending. Keywords Banking government regulation macroeconomic stabilization policy JEL Classification G21 G28 E61 The authors are a staff economist in the Division of International Finance and financial analyst in the Division of .

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