Identification of Moral Hazard in the Banking System of Iran

The presence of moral hazard in the banking sector can have worrying results. This paper examines the role of government guarantees to banks in generating moral hazard in Iran. We test for moral hazard among bank creditors by determining whether protected banks received more funds from creditors than non-protected banks. Empirically, to determine the existence of moral hazard among bank managers, we examine whether managers of protected banks had more risk than their counterparts at non-protected banks. Using panel data, we find stronger evidence of moral hazard among bank managers than bank creditors. We test for moral hazard among bank managers by using the capital ratio as bank risk variable. The coefficient of the lag of capital ratio is significant. This is strong evidence for the existence of moral hazard among bank managers. The coefficient of loan asset ratio is negative and significant. Banks managers decrease bank lending in risky conditions. The coefficient of the Debt to Central Bank variable is significantly negative, suggesting that the Government protected banks face lower risks. This is strong evidence for the existence of moral hazard among bank managers. As a robustness check, we used the Z-score instead of capital ratio for survey of the effect of moral hazard on bank risks. We used the Z-score as an alternative to capital ratio. This results show that there is strong evidence for the existence of moral hazard among bank managers.JEL Classification: C23, E44, G21Received: 5/8/2014          Approved: 6/30/2014