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Monitoring, Liquidity and Financial Crises

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  • Mundaca, Gabriela

Abstract

This paper analyzes central bank policies on the monitoring of banks in distress in which liquidity provisions are conditional on performance when a bad shock occurs. A sequential game model is used to analyze two policies: the first one in which the central bank acts with discretion and the second in which the optimal monitoring policy rule is made public. The results show that banks exert less effort and take higher risks with a discretionary monitoring policy. With public information about monitoring rules, there is more central bank monitoring and less need to provide emergency funding. Public information about monitoring resolves the multiple equilibria that arise with discretion in fact, a unique equilibrium emerges in which the probability of a banking crisis is reduced.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 20501.

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Date of creation: 10 Mar 2008
Date of revision: 01 Oct 2009
Handle: RePEc:pra:mprapa:20501

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Keywords: monitoring liquidity provision financial crises conditionality;

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  1. X. Freixas, 2000. "Optimal Bail Out Policy, Conditionality and Constructive Ambiguity," DNB Staff Reports (discontinued) 49, Netherlands Central Bank.
  2. Eduardo Levy Yeyati & Tito Cordella, 1999. "Bank Bailouts," IMF Working Papers 99/106, International Monetary Fund.
  3. Acharya, Viral V & Yorulmazer, Tanju, 2004. "Too Many to Fail - An Analysis of Time Inconsistency in Bank Closure Policies," CEPR Discussion Papers 4778, C.E.P.R. Discussion Papers.
  4. Gasbarro, Dominic & Sadguna, I Gde Made & Zumwalt, J Kenton, 2002. " The Changing Relationship Between CAMEL Ratings and Bank Soundness during the Indonesian Banking Crisis," Review of Quantitative Finance and Accounting, Springer, vol. 19(3), pages 247-60, November.
  5. 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.
  6. Goodhart, Charles A.E. & Huang, Haizhou, 2005. "The lender of last resort," Journal of Banking & Finance, Elsevier, vol. 29(5), pages 1059-1082, May.
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