DP4727 Policies for Banking Crises: A Theoretical Framework

Author(s): Rafael Repullo
Publication Date: November 2004
Keyword(s): bank runs, bank supervision, banking crises, deposit insurance, forbearance, lender of last resort, risk-shifting incentives
JEL(s): E58, G21, G28
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4727

This Paper analyses the effects on ex ante risk-shifting incentives and ex post fiscal costs of three policies that are frequently used in dealing with banking crises, namely, forbearance from prudential regulations, extension of blanket deposit guarantees, and provision of unrestricted liquidity support. In the context of a simple model of information-based bank runs, where banks are funded with both insured and uninsured deposits, the paper shows that the expectation of implementation of any of these policies leads to a reduction in the interest rate of uninsured deposits and in the bank?s incentives to take risk, but increases the expected fiscal costs of the crises.