Bank valuation: The ‘dark' side of expected government support

We use a large sample of more than 500 banks, from all over the world, to explore the effect of expected government support on bank valuation.

In doing this, we depart from the existing literature that so far has explored the size and determinants of the expected support, the funding advantage banks may derive from it, the potential distortions in competition and the moral hazard it creates for banks. Instead, we focus on the more direct benefits the expected support may have for bank shareholders which, if they exist, may exacerbate its negative externalities.

Contrary to expectations, our preliminary results indicate that that the proxy of the expected support is negatively related with bank valuation.

This surprising result seems robust to a number of alternative model specifications. In these, we use several control variables for country- and bank-specific characteristics. The bank-specific variables pertain to the structure of the balance sheet, the composition of the income statement and measures of bank-risk. The country-specific variables pertain to the state of the macroeconomy, the quality of economic policy, the existence of imbalances and the institutional characteristics of the country. We also split the sample along several lines to explore whether the results are due to big banks or to high-graded banks, or whether they are confined to banks from developed countries. 

We also explore potential explanations as well as related policy concerns. Among the latter are ways to reduce the negative externalities of expected bank-support, strengthen market discipline, and better align the incentives of shareholders and other bank-stakeholders.