Agency Problems in Banking: Types of and Incentives for Risk Shifting

The banking literature has extensively examined risk shifting, especially in theoretical terms and in relation to the safety net and regulation. To set a framework of analysis for this moral hazard problem, we provide a brief synthesis of the incentive scheme underlying risk shifting. Then, we propose an empirical method to determine whether banks engage in risk shifting. This method also allows us, first, to classify risk shifting practices depending on the group of creditors to which shareholders transfer risk (that is, our method implies a taxonomy of risk shifting), and second, to identify positive and negative incentives for risk shifting. We apply our method to the banking systems of the United States and the European Union and discuss the resulting findings.