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Banking Concentration: Implications for Systemic Risk and Safety Net Design

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  • Rodrigo Cifuentes
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    Abstract

    This paper explores the impact of banking concentration on safety net design –in particular, deposit insurance– and on systemic risk. The paper focuses on a system characterized by high concentration and low total number of banks. Each issue is addressed separately. The first section discusses best practices in deposit insurance design and derives conclusions for the case we are interested in. One is that in this context deposit insurance cannot be thought of as a stand-alone instrument, but rather must be understood as an element of the intervention and resolution policy. The second part of the paper studies systemic risk in such a system, using the Eisenberg and Noe (2001) approach to model and study risk in a network of banks. A working metric of the “too big to fail” situation can be derived in the model. More importantly, this section shows how the risk of idiosyncratic shocks spreading through the system are substantially higher in concentrated systems than in decentralized ones. Finally, the paper proposes and evaluates a specific regulatory measure that successfully contains systemic risk.

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    Bibliographic Info

    Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 231.

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    Date of creation: Oct 2003
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    Handle: RePEc:chb:bcchwp:231

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    1. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
    2. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
    3. James, Christopher, 1991. " The Losses Realized in Bank Failures," Journal of Finance, American Finance Association, vol. 46(4), pages 1223-42, September.
    4. Gary Gorton, 1986. "Banking panics and business cycles," Working Papers 86-9, Federal Reserve Bank of Philadelphia.
    5. Rochet, Jean-Charles & Tirole, Jean, 1996. "Interbank Lending and Systemic Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 733-62, November.
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