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Designing financial safety nets to fit country circumstances

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  • Kane, Edward J.
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    Abstract

    The author explains how differences in the informational and contracting environments of countries affect the optimal design of their financial safety nets and their optimal strategies for managing financial crises. He explains how to design and operate safety nets at minimum cost to taxpayers and well-managed banks in countries whose informational and contracting technologies differ. His basic premise is that optimal regulation is not a one-size-fits-all proposition. A country's safety net should be transparent, deterrent to too much risk-taking, and accountable, but the author shows large differences across countries in the transparency and deterrence banks afford their depositors, highlighting why the design of safety nets must allow for differences in the enforceability of private contracts. The weaker a country's informational, ethical, and corporate governance environment, the more a wholly governmental system of explicit deposit guarantees is apt to undermine bank safety and stability. How a country's safety net evolves depends on the ability of the private and public sectors to value banks, discipline risk-taking, and resolve financial difficulties promptly. And political accountability is essential if the public part of these tasks is to evolve effectively and efficiently. As a rule of thumb, safety-net managers should avoid either subsidizing or taxing bank risk-taking, says the author. Even if analysts could formulate a beneficial tax or subsidy rule, it is unlikely that channeling the effect through a government-run deposit insurance system that fails to account publicly for the size of taxpayers'stake could improve upon more straightforward arrangements.

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    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2453.

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    Date of creation: 30 Sep 2000
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    Handle: RePEc:wbk:wbrwps:2453

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    Related research

    Keywords: Financial Intermediation; Banks&Banking Reform; Insurance&Risk Mitigation; Labor Policies; Payment Systems&Infrastructure; Banks&Banking Reform; Financial Intermediation; Insurance&Risk Mitigation; Financial Crisis Management&Restructuring; Environmental Economics&Policies;

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    1. Talley, Samuel H. & Mas, Ignacio, 1990. "Deposit insurance in developing countries," Policy Research Working Paper Series 548, The World Bank.
    2. Anna J. Schwartz, 1999. "Is There a Need for an International Lender of Last Resort?," Cato Journal, Cato Journal, Cato Institute, vol. 19(1), pages 1-6, Spring/Su.
    3. Black, Fischer & Miller, Merton H & Posner, Richard A, 1978. "An Approach to the Regulation of Bank Holding Companies," The Journal of Business, University of Chicago Press, vol. 51(3), pages 379-412, July.
    4. Rafael La Porta & Florencio Lopez-De-Silanes & Andrei Shleifer, 2002. "Government Ownership of Banks," Journal of Finance, American Finance Association, vol. 57(1), pages 265-301, 02.
    5. Cukierman, Alex & Webb, Steven B & Neyapti, Bilin, 1992. "Measuring the Independence of Central Banks and Its Effect on Policy Outcomes," World Bank Economic Review, World Bank Group, vol. 6(3), pages 353-98, September.
    6. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    7. Asli Demirguc-Kunt & Enrica Detragiache, 2000. "Does Deposit Insurance Increase Banking System Stability? An Empirical Investigation," Econometric Society World Congress 2000 Contributed Papers 1751, Econometric Society.
    8. 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.
    9. Robert C. Merton & André Perold, 1993. "Theory Of Risk Capital In Financial Firms," Journal of Applied Corporate Finance, Morgan Stanley, vol. 6(3), pages 16-32.
    10. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
    11. Calomiris, Charles W., 1999. "Building an incentive-compatible safety net," Journal of Banking & Finance, Elsevier, vol. 23(10), pages 1499-1519, October.
    12. Smith, Clifford Jr. & Warner, Jerold B., 1979. "On financial contracting : An analysis of bond covenants," Journal of Financial Economics, Elsevier, vol. 7(2), pages 117-161, June.
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    Cited by:
    1. Cull, Robert & Senbet, Lemma W. & Sorge, Marco, 2002. "The effect of deposit insurance on financial depth: A cross-country analysis," The Quarterly Review of Economics and Finance, Elsevier, vol. 42(4), pages 673-694.
    2. Chernykh, Lucy & Cole, Rebel A., 2011. "Does deposit insurance improve financial intermediation? Evidence from the Russian experiment," Journal of Banking & Finance, Elsevier, vol. 35(2), pages 388-402, February.
    3. Sawada, Michiru, 2010. "Liquidity risk and bank portfolio management in a financial system without deposit insurance: Empirical evidence from prewar Japan," International Review of Economics & Finance, Elsevier, vol. 19(3), pages 392-406, June.
    4. Robert J. Dijkstra & Michael G. Faure, 2011. "Compensating victims of bankrupted financial institutions: a law and economic analysis," Journal of Financial Regulation and Compliance, Emerald Group Publishing, vol. 19(2), pages 156-173, May.
    5. Richard J. Herring & Nathporn Chatusripitak, 2000. "The Case of the Missing Market: The Bond Market and Why It Matters for Financial Development," Center for Financial Institutions Working Papers 01-08, Wharton School Center for Financial Institutions, University of Pennsylvania.
    6. Asli Demirguc-Kunt & Edward J. Kane, 2002. "Deposit Insurance Around the Globe: Where Does It Work?," Journal of Economic Perspectives, American Economic Association, vol. 16(2), pages 175-195, Spring.
    7. Asli Demirgüç-Kun & Edward J. Kane, 2003. "Deposit Insurance: Handle With Care," Working Papers Central Bank of Chile 227, Central Bank of Chile.
    8. Fernandez, Ana I. & Gonzalez, Francisco, 2005. "How accounting and auditing systems can counteract risk-shifting of safety-nets in banking: Some international evidence," Journal of Financial Stability, Elsevier, vol. 1(4), pages 466-500, October.
    9. Kane, Edward J., 2002. "Resolving systemic financial crises efficiently," Pacific-Basin Finance Journal, Elsevier, vol. 10(3), pages 217-226, June.
    10. Beck, Thorsten, 2002. "Deposit insurance as private club: is Germany a model?," The Quarterly Review of Economics and Finance, Elsevier, vol. 42(4), pages 701-719.
    11. Hovakimian, Armen & Kane, Edward J. & Laeven, Luc, 2002. "How Country and Safety-Net Characteristics Affect Bank Risk-Shifting," CEI Working Paper Series 2002-10, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University.
    12. Hoggarth, Glenn & Jackson, Patricia & Nier, Erlend, 2005. "Banking crises and the design of safety nets," Journal of Banking & Finance, Elsevier, vol. 29(1), pages 143-159, January.
    13. Laeven, Luc, 2002. "Pricing of deposit insurance," Policy Research Working Paper Series 2871, The World Bank.
    14. Gonzalez, Francisco, 2005. "Bank regulation and risk-taking incentives: An international comparison of bank risk," Journal of Banking & Finance, Elsevier, vol. 29(5), pages 1153-1184, May.
    15. Laeven, Luc, 2002. "International evidence on the value of deposit insurance," The Quarterly Review of Economics and Finance, Elsevier, vol. 42(4), pages 721-732.
    16. Demirguc-Kunt, Asli & Kane, Edward J. & Laeven, Luc, 2006. "Deposit insurance design and implementation : policy lessons from research and practice," Policy Research Working Paper Series 3969, The World Bank.
    17. Fotios Pasiouras & Chrysovalantis Gaganis & Constantin Zopounidis, 2006. "The impact of bank regulations, supervision, market structure, and bank characteristics on individual bank ratings: A cross-country analysis," Review of Quantitative Finance and Accounting, Springer, vol. 27(4), pages 403-438, December.

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