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

Listed author(s):
  • Raphael H. Solomon
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    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.

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    File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/02/wp05-23.pdf
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    Paper provided by Bank of Canada in its series Staff Working Papers with number 05-23.

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    Length: 37 pages
    Date of creation: 2005
    Handle: RePEc:bca:bocawp:05-23
    Contact details of provider: Postal:
    234 Wellington Street, Ottawa, Ontario, K1A 0G9, Canada

    Phone: 613 782-8845
    Fax: 613 782-8874
    Web page: http://www.bank-banque-canada.ca/

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    16. Rafael La Porta & Florencio Lopez-de-Silane & Guillermo Zamarripa, 2002. "Related Lending," NBER Working Papers 8848, National Bureau of Economic Research, Inc.
    17. Furfine, Craig H, 2003. " Interbank Exposures: Quantifying the Risk of Contagion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(1), pages 111-128, February.
    18. Petersen, Mitchell A & Rajan, Raghuram G, 1994. " The Benefits of Lending Relationships: Evidence from Small Business Data," Journal of Finance, American Finance Association, vol. 49(1), pages 3-37, March.
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