Description

This paper examines the agency problems that arise when a Central Bank rescues a failing bank. Specifically, the objectives of this paper are to determine: (1) the agency problems that derive from the mechanism of the purchase of risky loans and (2) the response of the banks to the incentives that they face when the Central Bank purchased their risky loans. The empirical evidence from the Chilean banking crisis of the 1980s shows that the rescued banks had higher levels of risk and they were less efficient. However, it is not clear that the higher level of risks were due to moral hazard behavior. I also found that some additional measures mitigated the agency problems. These mitigating factors included limiting the amount of financial assistance per bank, the closing or selling of the banks with more serious solvency problems and, the designation of Provisional Administrator in some banks.