Abolishing Public Guarantees in the Absence of Market Discipline # 437

The working papers published in the Series constitute work in progress circulated to stimulate discussion and critical comments. Views expressed represent exclusively the authors' own opinions and do not necessarily refl ect those of the editors. Die Deutsche Bibliothek verzeichnet diese Publikation in der deutschen National-bibliografi e; detaillierte bibliografi sche Daten sind im Internet über: Abstract This paper shows that the abolition of state guarantees to publicly owned banks in Germany resulted in an increase in funding costs at German savings banks. Rather than being the result of increased market discipline, the increase in funding costs is shown to be driven by spillover eff ects from German Landesbanken who themselves had suff ered from the abolition of guarantees and who spread their own cost increase through the public banking network. Higher funding costs and the resulting drop in bank charter values translated into higher risk-taking at German savings bank.