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The relationship between excessive lending, risk premium and risk‐taking: Evidence from European banks

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  • Thaer Alhalabi
  • Vitor Castro
  • Justine Wood
Abstract
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 sample of 149 European banks during the period 2001–2016, we show that the risk management hypothesis holds for the period after the 2007–2008 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.

Suggested Citation

  • Thaer Alhalabi & Vitor Castro & Justine Wood, 2023. "The relationship between excessive lending, risk premium and risk‐taking: Evidence from European banks," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 28(1), pages 448-471, January.
    • Handle: RePEc:wly:ijfiec:v:28:y:2023:i:1:p:448-471
    DOI: 10.1002/ijfe.2430
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