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The Design of Government Guarantees for Bank Bonds: Lessons from the Recent Financial Crisis

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  • Aviram Levy
  • Sebastian Schich
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    Abstract

    In 2010 authorities have taken the first steps to end some of the public support measures put in place in response to the financial crisis, starting with government guarantees for bond issues. Financial institutions have made extensive use of this tool, which has been effective in avoiding a further tightening of funding conditions, but this type of public support has, nonetheless, raised some concerns. First, the cost of issuing guaranteed bonds has mainly reflected the characteristics of the sovereign guarantor rather than those of the issuer, thus favouring “weak” borrowers with a “strong” sovereign backing. This situation has the potential to distort competition and create incentives for excessive risk taking. Such effects could have been reduced by the choice of a different fee determination mechanism. Second, the continued availability in 2010 of guarantee schemes, despite a declining overall usage, may be alleviating the pressure on some weak financial institutions to address their weaknesses: the average creditworthiness of banks issuing after mid-2009, when market conditions became more favourable, has sharply declined. JEL Classification: G01, G12, G21, G28. Keywords: financial crisis, policy response to the crisis, government guaranteed bonds, competitive distortions

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    File URL: http://dx.doi.org/10.1787/fmt-2010-5km7k9tp8t40
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    Bibliographic Info

    Article provided by OECD Publishing in its journal OECD Journal: Financial Market Trends.

    Volume (Year): 2010 (2010)
    Issue (Month): 1 ()
    Pages: 35-66

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    Handle: RePEc:oec:dafkad:5km7k9tp8t40

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    Cited by:
    1. Nicola Cetorelli & Linda Goldberg, 2011. "Liquidity management of U.S. global banks: internal capital markets in the Great Recession," Staff Reports 511, Federal Reserve Bank of New York.
    2. Andrea Cardillo & Andre Zaghini, 2012. "The recent trends in long-term bank funding," Questioni di Economia e Finanza (Occasional Papers) 137, Bank of Italy, Economic Research and International Relations Area.
    3. Jakob Eberl & Christopher Weber, 2014. "ECB Collateral Criteria: A Narrative Database 2001–2013," Ifo Working Paper Series Ifo Working Paper No. 174, Ifo Institute for Economic Research at the University of Munich.
    4. Scott E. Page, 2012. "A complexity perspective on institutional design," Politics, Philosophy & Economics, , vol. 11(1), pages 5-25, February.

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