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Illiquidity, insolvency, and banking regulation

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  • Jin Cao

    ()
    (Norges Bank (Central Bank of Norway))

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Abstract

This paper provides a compact framework for banking regulation analysis in the presence of uncertainty between systemic liquidity and solvency shocks. It explains the asset price anomalies and bank lending freeze during the crisis. The paper shows how the coexistence of illiquidity and insolvency problems adds extra cost for banking regulation, making conventional regulatory policies fail, and why the unconventional central bank policy encourages moral hazard. A banking tax is proposed to cover the extra regulatory cost, and the regulatory cost can also be reduced by combining the advantages of several instruments.

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File URL: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2011/WP-201113/
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Bibliographic Info

Paper provided by Norges Bank in its series Working Paper with number 2011/13.

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Length: 38 pages
Date of creation: 21 Nov 2011
Date of revision:
Handle: RePEc:bno:worpap:2011_13

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Related research

Keywords: Liquidity risk; Insolvency risk; Liquidity regulation; Equity requirement; Banking tax;

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  1. Patrick Bolton & Tano Santos & Jose A. Scheinkman, 2011. "Outside and Inside Liquidity," The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 259-321.
  2. Acharya, Viral V., 2009. "A theory of systemic risk and design of prudential bank regulation," Journal of Financial Stability, Elsevier, vol. 5(3), pages 224-255, September.
  3. Viral V. Acharya & Tanju Yorulmazer, 2008. "Cash-in-the-Market Pricing and Optimal Resolution of Bank Failures," Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2705-2742, November.
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