Lenders That Received TARP Money Increased Risk Level: Report

A recent report reveals banks that received federal funding from the Troubled Asset Relief Program (TARP) have since increased their risk level by about 10 percent.

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Professors Ran Duchin and Denis Sosyura from the Michigan Ross School of Business studied risk among banks that received TARP funds and banks that did not, controlling for volume and quality of credit demand to account for changes in economic conditions.

""Our main finding is that after receiving federal capital, bailed banks shifted their credit origination toward riskier mortgages, as measured by the borrower's loan-to income ratio and the high-risk loan indicator based on the loan rate,"" Duchin and Sosyura state in their report.

The researchers found that the amount of originated credit was not affected. However, the risk inherent in the loans was higher.

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Though risk increased among bailed-out banks, the increased risks were generally in the same asset class and thus did not affect the banks' capitalization levels.

""Consequently, bailed banks appear safer according to the capitalization requirements, but show a significant increase in market-based measures of risk,"" the report states.

TARP recipients absorbed the riskier mortgages on the market, leaving other banks to lower their percentage of risky loans.

Exploring reasons for the increased risk, the researchers suggest perhaps the Treasury purposely distributed funds to banks who were ""more likely to experience a significant future shock as a result of their crisis exposure of other factors.""

Were this the case, TARP banks might be experiencing less risk than they otherwise would have, even if it is an increase.

Duchin and Sosyuran also explore the impact that government credit policies had on the banks' risk-taking. However, they note that any government restrictions ""were explicitly imposed to reduce rather than increase bank risk taking.""

""From a policy perspective, our findings show that any capital provisions should establish clear investment guidelines and provide mechanisms for tracking the deployment of capital by recipient institutions in order to limit the unintended consequences of government aid,"" the report concludes.