Reputational Contagion and Optimal Regulatory Forbearance

Alan Morrison and Lucy White

No 9508, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Existing studies suggest that systemic crises may arise because banks either hold correlated assets, or are connected by interbank lending. This paper shows that common regulation is also a conduit for interbank contagion. One bank?s failure may undermine confidence in the banking regulator?s competence, and, hence, in other banks chartered by the same regulator. As a result, depositors withdraw funds from otherwise unconnected banks. The optimal regulatory response to this behaviour can be privately to exhibit forbearance to a failing bank. We show that regulatory transparency improves confidence ex ante but impedes regulators? ability to stem panics ex post.

Keywords: Bank regulation; Contagion; Reputation (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2013-06
New Economics Papers: this item is included in nep-ban and nep-cba
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Citations: View citations in EconPapers (65)

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