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Peer monitoring via loss mutualization

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  • Francesco Palazzo

    () (Bank of Italy)

Abstract

After the 2008 financial crisis, the allocation of losses resulting from a bank bankruptcy has been one of the main policy issues. Several new regulatory provisions increased the burden of losses endured by the rest of the financial industry. For example, bank resolution schemes and mandatory clearing through Central Counterparties (CCPs) introduce mechanisms to share losses among surviving banks, with an emphasis on ensuring a sufficient loss absorption capacity. Without understating this relevant concern, this article suggests that a loss mutualization scheme may also foster market discipline by other banks (peers) if combined with an appropriate design of the relevant metrics used to allocate losses among surviving banks. The optimal design should impose higher contributions on banks with closer interlinkages with the defaulter. In this respect, the results highlight how the allocation of losses beyond the defaulter's initial contribution plays a considerable role on peer monitoring incentives.

Suggested Citation

  • Francesco Palazzo, 2016. "Peer monitoring via loss mutualization," Temi di discussione (Economic working papers) 1088, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_1088_16
    as

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    File URL: http://www.bancaditalia.it/pubblicazioni/temi-discussione/2016/2016-1088/en_tema_1088.pdf
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    References listed on IDEAS

    as
    1. Valeriya Dinger & Jürgen Von Hagen, 2009. "Does Interbank Borrowing Reduce Bank Risk?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(2-3), pages 491-506, March.
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    5. David Mills & Francesca Carapella, 2012. "Information insensitive securities: the benefits of central counterparties," 2012 Meeting Papers 1032, Society for Economic Dynamics.
    6. Becker, Gary S, 1973. "A Theory of Marriage: Part I," Journal of Political Economy, University of Chicago Press, vol. 81(4), pages 813-846, July-Aug..
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    peer monitoring; default fund; resolution fund; clearinghouse; collateral;

    JEL classification:

    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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