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On the Causes of Overlending: Are Guarantees on Deposits the Culprit?

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  • Giannetti, Mariassunta

Abstract

Conventional wisdom holds that overlending problems and banking crises in open economies are provoked by investor moral hazard, which is caused in turn by guarantees on deposits. This Paper shows that this is not necessarily the case: guarantees on deposits may even limit the losses banks accumulate. In the model, banks may rationally accumulate bad loans if international investors have incomplete information on firm profitability and initially provide funds at low cost. In equilibrium, international investors rationally require a risk premium and banks stop renewing bad loans, only when a substantial amount of losses has been accumulated. This feature of the equilibrium does not depend on whether or not there are guarantees on deposits. Transparency and bond market development can eliminate overlending problems and prevent banking crises.

Suggested Citation

  • Giannetti, Mariassunta, 2003. "On the Causes of Overlending: Are Guarantees on Deposits the Culprit?," CEPR Discussion Papers 4055, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:4055
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    Cited by:

    1. Billett, Matthew T. & Garfinkel, Jon A. & Jiang, Yi, 2011. "The influence of governance on investment: Evidence from a hazard model," Journal of Financial Economics, Elsevier, vol. 102(3), pages 643-670.
    2. Frederic Chabellard, 2001. "Dollarization of Liabilities in Non-tradable Goods Sector," William Davidson Institute Working Papers Series 380, William Davidson Institute at the University of Michigan.

    More about this item

    Keywords

    bank-firm relationships; banking crises; bond markets; guarantees on deposits; transparency;

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • 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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