Government Interventions - Restoring or Destroying Financial Stability in the Long-Run?

Recent government interventions in the banking sector have raised a considerable controversy among the academicians, politicians and policymakers. One of the reasons is an increasing concern about long-run effects of government banks' bailouts. The existing academic literature is very mute with this respect. This paper closes the gap and investigates the effect of various bailout strategies on long-term banking sector stability. Investigating the behavior of bailed banks versus non-bailed competitors it also identifies the sources of these effects. Our results show that government interventions destabilize banking sectors in the long-run. Especially, public guarantees, nationalization of private institutions as well as creation of asset management companies (AMCs) (also so-called "The Troubled Asset Relief Funds" or "Bad Banks") increase the risk-taking of bailed institutions several years afterwards. We show that these effects are related to lack of appropriate restructuring changes in the bailed institutions what does not allow them to restore their operating performance. This in turn is a result of state ownership and diminished market control.