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Loan guarantees, bank underwriting policies and financial stability

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  • Carletti, Elena
  • Leonello, Agnese
  • Marquez, Robert

Abstract

Loan guarantees represent a form of government intervention to support bank lending. However, their use raises concerns as to their effect on bank risk-taking incentives. In a model of financial fragility that incorporates bank capital and a bank incentive problem, we show that loan guarantees reduce depositor runs and improve bank underwriting standards, except for the most poorly capitalized banks. We highlight a novel feedback effect between banks’ underwriting choices and depositors’ run decisions, and show that the effect of loan guarantees on banks’ incentives is different from that of other types of guarantees, such as deposit insurance.

Suggested Citation

  • Carletti, Elena & Leonello, Agnese & Marquez, Robert, 2023. "Loan guarantees, bank underwriting policies and financial stability," Journal of Financial Economics, Elsevier, vol. 149(2), pages 260-295.
    • Handle: RePEc:eee:jfinec:v:149:y:2023:i:2:p:260-295
    DOI: 10.1016/j.jfineco.2023.04.013
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    More about this item

    Keywords

    Panic runs; Fundamental runs; Bank monitoring; Charter value;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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