Banking with Contingent Contracts, Macroeconomic Risks, and Banking Crises

Hans Gersbach

No 08/93, CER-ETH Economics working paper series from CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich

Abstract: We examine banking competition when deposit or loan contracts contingent on macroeconomic shocks become feasible. We show that the risk allocation is efficient, provided that banks are not bailed out. In this case, banks may shift part of the risk to depositors. The private sector insures the banking sector and banking crises are avoided. In contrast, when banks are bailed out, depositors receive non-contingent contracts with high interest rates, while entrepreneurs obtain loan contracts that demand high repayment in good times and low repayment in bad times. As a result, the present generation overinvests, and banks create large macroeconomic risks for future generations, even if the underlying risk is small or zero.

Keywords: Financial intermediation; macroeconomic risks; state contingent contracts; banking regulation (search for similar items in EconPapers)
JEL-codes: D41 E4 G2 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2008-08
New Economics Papers: this item is included in nep-ban, nep-bec, nep-mac and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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