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Pocket Banks and Out-of-Pocket Losses: Links between Corruption and Contagion

Author

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  • Raphael H. Solomon

Abstract

The author describes a model with a corrupt banking system, in which bankers knowingly lend at market interest rates to back projects riskier than the market rate indicates. Faced with early withdrawals, bankers turn to an interbank market, which may be available in an unfettered way, available but subject to screening, or unavailable. The presence of corruption increases the probability of contagious bank failure significantly. This fact holds in a perfect information environment, as well as in some environments with imperfect information. The model suggests that financial stability can be imperilled by corrupt lending.

Suggested Citation

  • Raphael H. Solomon, 2005. "Pocket Banks and Out-of-Pocket Losses: Links between Corruption and Contagion," Staff Working Papers 05-23, Bank of Canada.
  • Handle: RePEc:bca:bocawp:05-23
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    References listed on IDEAS

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    Cited by:

    1. Erotokritos Varelas, 2017. "Is bank lending corruption self-regulatory? A note," Discussion Paper Series 2017_03, Department of Economics, University of Macedonia, revised Mar 2017.

    More about this item

    Keywords

    Financial institutions; Financial stability;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G19 - Financial Economics - - General Financial Markets - - - Other
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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