Financial Institutions, Financial Contagion, and Financial Crises
AbstractThis paper endogenizes financial contagion and financial crises from financial institutions. We show that financial crises can emanate from financial institutions which generate soft-budget constraints (SBC). The prevailing SBC in an economy distort in-formation such that the interbank lending market faces a "lemon" problem. The lemon problem in the lending market may contribute to bank-run contagions and can lead to the collapse of the lending market while inducing a run on the economy. Moreover, due to the lemon problem in the financial system, a rational government policy in this economy will lead to a SBC trap that all the illiquid banks are to be bailed out. In comparison, we show that an economy with a predominance of diversified financial institutions will be featured by hard-budget constraints. From this point, we show mechanisms that in this economy firms disclose timely information to the banks and to the financial market as a whole. Thus bank runs can be stopped, contagious risks contained and financial crisis prevented.
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Bibliographic InfoPaper provided by Center for International Development at Harvard University in its series CID Working Papers with number 21.
Date of creation: Jul 1999
Date of revision:
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Postal: Center for International Development at Harvard University (CID). 79 John F. Kennedy Street, Cambridge, MA 02138.
Web page: http://www.cid.harvard.edu/cidwp/
More information through EDIRC
Financial Institutions; Corporate Finance; Bank Run; Financial Contaigion; Financial Crisis;
Other versions of this item:
- Huang, H. & Xu, C., 2000. "Financial Institutions, Financial Contagion, and Financial Crises," Papers 21, Chicago - Graduate School of Business.
- Haizhou Huang & Chenggang Xu, 2000. "Financial Institutions, Financial Contagion, and Financial Crises," William Davidson Institute Working Papers Series 316, William Davidson Institute at the University of Michigan.
- Haizhou Huang & Chenggang Xu, 2000. "Financial Institutions, Financial Contagion, and Financial Crises," IMF Working Papers 00/92, International Monetary Fund.
- Haizhou Huang, 2000. "Financial Institutions, Financial Contagion, and Financial Crises," Econometric Society World Congress 2000 Contributed Papers 1595, Econometric Society.
- D2 - Microeconomics - - Production and Organizations
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- G2 - Financial Economics - - Financial Institutions and Services
- G3 - Financial Economics - - Corporate Finance and Governance
- P5 - Economic Systems - - Comparative Economic Systems
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