Banks' changing incentives and opportunities for risk taking

This paper investigates the deterioration of the banking industry's risk-control system during the 1980s and the time-varying relation between a bank's ex-ante risk-taking incentives and its ex-post risk-taking behavior over the period 1977–1994. We document that banks with high charter value imposed self-discipline on risk-taking behavior at all times. In contrast, banks with low charter value assumed significantly more risk beginning around 1983, and this behavior continued into the early 1990s. These findings have several important policy implications.