The relationship between excessive lending, risk premium and risk-taking: evidence from European banks

Banks normally trade-off the amount of loans created by the amount of risk piled up in their assets portfolios. However, their performance can induce a ‘search for yield’ or ‘gamble to survive’ behaviour. Using a sample of 149 European banks during the period 2001-2016, we show that the risk management hypothesis holds for the period after the 2007-08 financial crisis and for large banks. Contrarily, the moral hazard hypothesis, under which banks practise excessive lending to relatively risky borrowers that pay higher premium but increase their credit risk, is supported in the pre-crisis period and for small banks. Additionally, we provide important implications to suggest that the post-crisis regulations have restrained banks with poor performance from the ‘gamble to survive’ behaviour.