Abstract:We provide evidence that regions in the U.S. with higher income inequality tend to have a riskier banking sector. However, not all banks are more risky, as reflected in a higher dispersion of bank risk. We show how a model based on risk-shifting incentives where banks channel insured deposits into subprime loans can account for both findings. In equilibrium, a competition to risk-shift emerges, leading to a subprime lending boom in which loans to high-risk borrowers carry negative NPVs. Some banks engage in ri… Show more
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