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Contingent Contracts in Banking: Insurance or Risk Magnification?

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  • HANS GERSBACH

Abstract

What happens when banks compete with deposit and loan contracts contingent on macro‐economic shocks? The private sector insures the banking system efficiently against crises through such contracts when failing banks go bankrupt. When risks are large, banks may shift part of the risk to depositors who receive state‐contingent contracts. In contrast, when failing banks are rescued, new phenomena such as risk magnification emerge. Depositors receive noncontingent contracts, while loan contracts demand high repayment in good times and low repayment in bad times. Banks overinvest and generate large macro‐economic risks, even if the underlying productivity risk is small or zero.

Suggested Citation

  • Hans Gersbach, 2025. "Contingent Contracts in Banking: Insurance or Risk Magnification?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 57(1), pages 267-303, February.
    • Handle: RePEc:wly:jmoncb:v:57:y:2025:i:1:p:267-303
    DOI: 10.1111/jmcb.13113
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    More about this item

    JEL classification:

    • D41 - Microeconomics - - Market Structure, Pricing, and Design - - - Perfect Competition
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • G2 - Financial Economics - - Financial Institutions and Services

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