Government Guarantees and Financial Stability

Franklin Allen, Elena Carletti (), Itay Goldstein and Agnese Leonello

No 10560, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Government guarantees to financial institutions are intended to reduce the likelihood of runs and bank failures, but are also usually associated with distortions in banks? risk taking decisions. We build a model to analyze these trade-offs based on the global-games literature and its application to bank runs. We derive several results, some of which against common wisdom. First, guarantees reduce the probability of a run, taking as given the amount of bank risk taking, but lead banks to take more risk, which in turn might lead to an increase in the probability of a run. Second, guarantees against fundamental-based failures and panic-based runs may lead to more efficiency than guarantees against panic-based runs alone. Finally, there are cases where following the introduction of guarantees banks take less risk than would be optimal.

Keywords: Panic runs; Fundamental runs; Government guarantees; Bank moral hazard (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2015-04
New Economics Papers: this item is included in nep-ban, nep-cba and nep-cfn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (40)

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Related works:
Journal Article: Government guarantees and financial stability (2018)
Working Paper: Government guarantees and financial stability (2017)
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