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Bailouts and Systemic Insurance

Author/Editor: Giovanni Dell'Ariccia | Lev Ratnovski
Authorized for Distribution: November 12, 2013
Electronic Access: Free Full Text (PDF file size is 593KB)
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Summary: We revisit the link between bailouts and bank risk taking. The expectation of government support to failing banks creates moral hazard—increases bank risk taking. However, when a bank’s success depends on both its effort and the overall stability of the banking system, a government’s commitment to shield banks from contagion may increase their incentives to invest prudently and so reduce bank risk taking. This systemic insurance effect will be relatively more important when bailout rents are low and the risk of contagion (upon a bank failure) is high. The optimal policy may then be not to try to avoid bailouts, but to make them “effective”: associated with lower rents.
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Series: Working Paper No. 13/233
Subject(s): Banking crisis | Financial intermediation | Moral hazard | Banking systems | Risk management | Economic models
    Published:   November 12, 2013        
    ISBN/ISSN:   9781475514742/1018-5941   Format:   Paper
    Stock No:   WPIEA2013233   Pages:   28
    Price:   US$18.00
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