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Reputational contagion and optimal regulatory forbearance

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  • Morrison, Alan D.
  • White, Lucy
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    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 behavior 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 Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 110 (2013)
    Issue (Month): 3 ()
    Pages: 642-658

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    Handle: RePEc:eee:jfinec:v:110:y:2013:i:3:p:642-658

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: Contagion; Reputation; Bank regulation;

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    1. Heider, F. & Hoerova, M. & Holthausen, C., 2009. "Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk," Discussion Paper 2009-40 S, Tilburg University, Center for Economic Research.
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    Cited by:
    1. Hryckiewicz, Aneta, 2014. "The problem with government interventions: The wrong banks, inadequate strategies, or ineffective measures?," MPRA Paper 56730, University Library of Munich, Germany.

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