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Confidence Banking

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  • Guillermo L. Ordonez

    (Yale University)

Abstract

A shadow unregulated banking system flourished during the first decade of the century and suddenly collapsed in less than a year. It is widely accepted this shadow system was based on confidence, but it is not clear how confidence can spur so much and then disappear so fast. In this paper I argue confidence is sustained by the recognition that financial agents care about reputation. While reputation incentives generate an alternative cheaper than traditional banking to provide financing needs, it is also a fragile alternative, that may suddenly collapse. This implies financial regulation should be counter-cyclical, but not imposing more costs to traditional banking during good times but inducing more benefits to better firms during bad times.

Suggested Citation

  • Guillermo L. Ordonez, 2010. "Confidence Banking," 2010 Meeting Papers 310, Society for Economic Dynamics.
  • Handle: RePEc:red:sed010:310
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    File URL: https://economicdynamics.org/meetpapers/2010/paper_310.pdf
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    1. Ordoñez, Guillermo L., 2013. "Fragility of reputation and clustering of risk-taking," Theoretical Economics, Econometric Society, vol. 8(3), September.
    2. Gorton, Gary B., 2010. "Slapped by the Invisible Hand: The Panic of 2007," OUP Catalogue, Oxford University Press, number 9780199734153.
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