The ‘Celtic Crisis’: Guarantees, Transparency and Systemic Liquidity Risk
AbstractBank liability guarantee schemes have traditionally been viewed as costless measures to shore up investor confidence and prevent bank runs. However, as the experiences of some European countries, most notably Ireland, have demonstrated, the credibility and effectiveness of these guarantees are crucially intertwined with the sovereign’s funding risks. Employing methods from the literature on global games, we develop a simple model to explore the systemic linkage between the rollover risks of a bank and a government, which are connected through the government’s guarantee of bank liabilities. We show the existence and uniqueness of the joint equilibrium and derive its comparative static properties. In solving for the optimal guarantee numerically, we show how its credibility can be improved through policies that promote balance-sheet transparency. We explain the asymmetry in risk transfer between the sovereign and the banking sector, following the introduction of a guarantee as being attributed to the resolution of strategic uncertainties held by bank depositors and the opacity of the banks’ balance sheets.
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Bibliographic InfoPaper provided by Bank of Canada in its series Working Papers with number 13-31.
Length: 45 pages
Date of creation: 2013
Date of revision:
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Financial stability; Financial system regulation and policies;
Find related papers by JEL classification:
- G01 - Financial Economics - - General - - - Financial Crises
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
- D89 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Other
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-09-13 (All new papers)
- NEP-BAN-2013-09-13 (Banking)
- NEP-RMG-2013-09-13 (Risk Management)
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