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Collusion and Commitment in Bank Bailout

Yanhua Zhang
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Yanhua Zhang: GREMAQ, University of Toulouse

Industrial Organization from EconWPA

Abstract: Collusion and soft budget constraint are two conspicuous phenomena in transition economies¡¯ banking system. Literature has separately investigated those two phenomena from theoretical point of views. However, the cross-point of both phenomena has been neglected in the research of banking regulation. The present paper addresses this issue in a simple model of two-period contract with termination at the end of the first period. By comparing the two hierarchies -- ¡°bank-firm¡± and ¡°government-bank-firm¡±, we show that the government¡¯s non-commitment and banking bailout cause inefficiency in the contact relationship. Moreover, after introducing collusion possibility, non-commitment of the government increases the stakes, or bribes, which the collusive bank can extract, and makes it more costly for the government to implement this contract. However, taking into account the fact that the bank is collusive, the government who aims to prevent collusion will switch to the other equilibrium where she sticks to her commitment and excludes collusion from the contract relationship. Here, collusion plays a role as a hardening budget constraint device. Some policy implications are suggested at the end.

Keywords: soft budget constraint; collusion; moral hazard; commitment; transition; centralized economy. (search for similar items in EconPapers)
JEL-codes: C72 D23 D82 G14 H72 L23 P31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin and nep-fmk
Date: 2005-09-27
Note: Type of Document - pdf; pages: 38
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