Confidence Banking

Guillermo Ordonez

No 310, 2010 Meeting Papers from Society for Economic Dynamics

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.

Date: 2010
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed010:310

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