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Systemic Risk and Optimal Regulatory Architecture

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Author Info

  • Marco A Espinosa-Vega
  • Rafael Matta
  • Charles M. Kahn
  • Juan Sole

Abstract

Until the recent financial crisis, the safety and soundness of financial institutions was assessed from the perspective of the individual institution. The financial crisis highlighted the need to take systemic externalities seriously when rethinking prudential oversight and the regulatory architecture. Current financial reform legislation worldwide reflects this intent. However, these reforms have overlooked the need to also consider regulatory agencies'' forbearance and information sharing incentives. In a political economy model that explicitly accounts for systemic connectedness, and regulators'' incentives, we show that under an expanded mandate to explicitly oversee systemic risk, regulators would be more forbearing towards systemically important institutions. We also show that when some regulators have access to information regarding an institutions'' degree of systemic importance, these regulators may have little incentive to gather and share it with other regulators. These findings suggest that (and we show conditions under which) a unified regulatory arrangement can reduce the degree of systemic risk vis-á-vis a multiple regulatory arrangement.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 11/193.

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Length: 24
Date of creation: 01 Aug 2011
Date of revision:
Handle: RePEc:imf:imfwpa:11/193

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Related research

Keywords: Banks; Economic models; External shocks; Financial institutions; Financial risk; Liquidity; deposit insurance; systemic risk; banking; bank regulation; regulatory forbearance; financial crisis; bank lending; bank closure; bank failure; intervention powers; bank risk; deposit guarantees; bank risk-taking; bank incentive; distressed bank; bank monitoring; banking regulation; federal deposit insurance;

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References

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  1. Repullo, Rafael, 2000. "Who Should Act as Lender of Last Resort? An Incomplete Contracts Model," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 32(3), pages 580-605, August.
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  7. Stevens, Ed, 2000. "Comment on Deposit Insurance and Lender-of-Last-Resort Functions," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 32(3), pages 576-79, August.
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  13. Xavier Freixas, 1999. "Optimal Bail Out Policy, Conditionality and Creative Ambiguity," FMG Discussion Papers, Financial Markets Group dp327, Financial Markets Group.
  14. Fries, Steven & Mella-Barral, Pierre & Perraudin, William, 1997. "Optimal bank reorganization and the fair pricing of deposit guarantees," Journal of Banking & Finance, Elsevier, Elsevier, vol. 21(4), pages 441-468, April.
  15. Campbell, Tim S. & Chan, Yuk-Shee & Marino, Anthony M., 1992. "An incentive-based theory of bank regulation," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 2(3), pages 255-276, September.
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Cited by:
  1. Jorge Ponce & Marc Rennert, 2012. "Systemic banks and the lender of last resort," Documentos de Trabajo (working papers), Department of Economics - dECON 1812, Department of Economics - dECON.

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