Discussion Paper Details

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Title: Reputational Contagion and Optimal Regulatory Forbearance

Author(s): Alan Morrison and Lucy White

Publication Date: June 2013

Keyword(s): bank regulation, contagion and reputation

Programme Area(s): Financial Economics

Abstract: Existing studies suggest that systemic crises may arise because banks either hold correlated assets, or are connected by interbank lending. This paper shows that common regulation is also a conduit for interbank contagion. One bank?s failure may undermine confidence in the banking regulator?s competence, and, hence, in other banks chartered by the same regulator. As a result, depositors withdraw funds from otherwise unconnected banks. The optimal regulatory response to this behaviour can be privately to exhibit forbearance to a failing bank. We show that regulatory transparency improves confidence ex ante but impedes regulators? ability to stem panics ex post.

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Bibliographic Reference

Morrison, A and White, L. 2013. 'Reputational Contagion and Optimal Regulatory Forbearance'. London, Centre for Economic Policy Research.