DP9508 Reputational Contagion and Optimal Regulatory Forbearance
|Author(s):||Alan Morrison, Lucy White|
|Publication Date:||June 2013|
|Keyword(s):||bank regulation, contagion, reputation|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=9508|
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.