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The ‘Celtic Crisis’: Guarantees, transparency, and systemic liquidity risk

Philipp König, Kartik Anand and Frank Heinemann

SFB 649 Discussion Papers from Humboldt University, Collaborative Research Center 649

Abstract: Bank liability guarantee schemes have traditionally been viewed as costless measures to shore up investor confidence and stave off bank runs. However, as the experiences of some European countries, most notably Ireland, have demonstrated, the credibility and effectiveness of these guarantees is crucially intertwined with the sovereign’s funding risks. Employing methods from the literature on global games, we develop a simple model to explore the systemic linkage between the rollover risks of a bank and a government, which are connected through the government’s guarantee of bank liabilities. We show the existence and uniqueness of the joint equilibrium and derive its comparative static properties. In solving for the optimal guarantee numerically, we show how its credibility may be improved through policies that promote balance sheet transparency. We explain the asymmetry in risk-transfer between sovereign and banking sector, following the introduction of a guarantee as being attributed to the resolution of strategic uncertainties held by bank depositors and the opacity of the banks’ balance sheets.

Keywords: bank debt guarantees; transparency; bank default; sovereign default; global games (search for similar items in EconPapers)
JEL-codes: D89 G01 G28 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2013-05
New Economics Papers: this item is included in nep-ban, nep-eec and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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