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Collusion and Commitment in Bank Bailout

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  • Yanhua ZHANG

    (GREMAQ, University of Toulouse)

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    Abstract

    Collusion and soft budget constraint are two conspicuous phenomena in transition economies¡¯ banking system. Literature has separately investigated those two phenomena from theoretical point of views. However, the cross-point of both phenomena has been neglected in the research of banking regulation. The present paper addresses this issue in a simple model of two-period contract with termination at the end of the first period. By comparing the two hierarchies -- ¡°bank-firm¡± and ¡°government-bank-firm¡±, we show that the government¡¯s non-commitment and banking bailout cause inefficiency in the contact relationship. Moreover, after introducing collusion possibility, non-commitment of the government increases the stakes, or bribes, which the collusive bank can extract, and makes it more costly for the government to implement this contract. However, taking into account the fact that the bank is collusive, the government who aims to prevent collusion will switch to the other equilibrium where she sticks to her commitment and excludes collusion from the contract relationship. Here, collusion plays a role as a hardening budget constraint device. Some policy implications are suggested at the end.

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    File URL: http://128.118.178.162/eps/io/papers/0509/0509011.pdf
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    Bibliographic Info

    Paper provided by EconWPA in its series Industrial Organization with number 0509011.

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    Length: 38 pages
    Date of creation: 27 Sep 2005
    Date of revision:
    Handle: RePEc:wpa:wuwpio:0509011

    Note: Type of Document - pdf; pages: 38
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    Web page: http://128.118.178.162

    Related research

    Keywords: soft budget constraint; collusion; moral hazard; commitment; transition; centralized economy.;

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    1. Carlin, Wendy & Mayer, Colin, 1992. "Restructuring Enterprises in Eastern Europe," CEPR Discussion Papers 700, C.E.P.R. Discussion Papers.
    2. Begg, David & Portes, Richard, 1992. "Enterprise Debt and Economic Transformation: Financial Restructuring of the State Sector in Central and Eastern Europe," CEPR Discussion Papers 695, C.E.P.R. Discussion Papers.
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    7. Kornai, Janos, 1992. "The Socialist System: The Political Economy of Communism," OUP Catalogue, Oxford University Press, number 9780198287766.
    8. Bolton, Patrick & Scharfstein, David S, 1990. "A Theory of Predation Based on Agency Problems in Financial Contracting," American Economic Review, American Economic Association, vol. 80(1), pages 93-106, March.
    9. Kornai, J, 1979. "Resource-Constrained versus Demand-Constrained Systems," Econometrica, Econometric Society, vol. 47(4), pages 801-19, July.
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