Interbank Networks and Backdoor Bailouts: Benefiting from Other Banks’ Government Guarantees

Tim Eisert () and Christian Eufinger ()
Additional contact information
Tim Eisert: Erasmus University Rotterdam, 3062 PA Rotterdam, Netherlands
Christian Eufinger: IESE Business School, 08034 Barcelona, Spain6

Management Science, 2019, vol. 65, issue 8, 3673-3693

Abstract: This paper explains why banks derive a benefit from being highly interconnected. We show that when banks are protected by government guarantees, they can significantly increase their expected returns by channeling funds through the interbank market before these funds are invested in real assets. If banks that are protected by implicit or explicit government guarantees act as intermediaries between other banks and real investments, there is the possibility that these intermediary banks will be rescued by their governments if the real assets fail. This additional hedge increases the likelihood that banks and their creditors are repaid relative to a direct investment in those same real assets. We show that this incentive to exploit the government guarantees of other banks leads to long intermediation chains and a degree of interconnectedness that is above the welfare-optimal level, which justifies regulatory intervention.

Keywords: bailout; systemic risk; interconnectedness; herding; interbank network (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

Downloads: (external link)
https://doi.org/10.1287/mnsc.2017.2968 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:65:y:2019:i:8:p:3673-3693

Access Statistics for this article

More articles in Management Science from INFORMS Contact information at EDIRC.
Bibliographic data for series maintained by Chris Asher ().