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Reputational contagion and optimal regulatory forbearance

  • Morrison, Alan D.
  • White, Lucy
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    Existing studies suggest that systemic crises may arise because banks either hold correlated assets, or are connected by interbank lending. This paper shows that common regulation is also a conduit for interbank contagion. One bank's failure may undermine confidence in the banking regulator's competence, and, hence, in other banks chartered by the same regulator. As a result, depositors withdraw funds from otherwise unconnected banks. The optimal regulatory response to this behavior can be privately to exhibit forbearance to a failing bank. We show that regulatory transparency improves confidence ex ante but impedes regulators' ability to stem panics ex post.

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    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 110 (2013)
    Issue (Month): 3 ()
    Pages: 642-658

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    Handle: RePEc:eee:jfinec:v:110:y:2013:i:3:p:642-658
    DOI: 10.1016/j.jfineco.2013.08.011
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