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Illiquidity, insolvency, and banking regulation

Author

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  • Jin Cao

    () (Norges Bank (Central Bank of Norway))

Abstract

This paper provides a compact framework for banking regulation analysis in the presence of uncertainty between systemic liquidity and solvency shocks. It explains the asset price anomalies and bank lending freeze during the crisis. The paper shows how the coexistence of illiquidity and insolvency problems adds extra cost for banking regulation, making conventional regulatory policies fail, and why the unconventional central bank policy encourages moral hazard. A banking tax is proposed to cover the extra regulatory cost, and the regulatory cost can also be reduced by combining the advantages of several instruments.

Suggested Citation

  • Jin Cao, 2011. "Illiquidity, insolvency, and banking regulation," Working Paper 2011/13, Norges Bank.
  • Handle: RePEc:bno:worpap:2011_13
    as

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    File URL: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2011/WP-201113/
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    References listed on IDEAS

    as
    1. Acharya, Viral V., 2009. "A theory of systemic risk and design of prudential bank regulation," Journal of Financial Stability, Elsevier, vol. 5(3), pages 224-255, September.
    2. Patrick Bolton & Tano Santos & Jose A. Scheinkman, 2011. "Outside and Inside Liquidity," The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 259-321.
    3. Viral V. Acharya & Tanju Yorulmazer, 2008. "Cash-in-the-Market Pricing and Optimal Resolution of Bank Failures," Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2705-2742, November.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Liquidity risk; Insolvency risk; Liquidity regulation; Equity requirement; Banking tax;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • 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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