Banking with Contingent Contracts, Macroeconomic Risks, and Banking Crises
AbstractWe examine banking competition when deposit or loan contracts contingent on macroeconomic shocks become feasible. We show that the risk allocation is efficient, provided that banks are not bailed out. In this case, banks may shift part of the risk to depositors. The private sector insures the banking sector and banking crises are avoided. In contrast, when banks are bailed out, depositors receive non-contingent contracts with high interest rates, while entrepreneurs obtain loan contracts that demand high repayment in good times and low repayment in bad times. As a result, the present generation overinvests, and banks create large macroeconomic risks for future generations, even if the underlying risk is small or zero.
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Bibliographic InfoPaper provided by CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich in its series CER-ETH Economics working paper series with number 08/93.
Length: 37 pages
Date of creation: Aug 2008
Date of revision:
Financial intermediation; macroeconomic risks; state contingent contracts; banking regulation;
Find related papers by JEL classification:
- D41 - Microeconomics - - Market Structure and Pricing - - - Perfect Competition
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
- G2 - Financial Economics - - Financial Institutions and Services
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-09-29 (All new papers)
- NEP-BAN-2008-09-29 (Banking)
- NEP-BEC-2008-09-29 (Business Economics)
- NEP-MAC-2008-09-29 (Macroeconomics)
- NEP-REG-2008-09-29 (Regulation)
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