Monitoring, liquidity provision and financial crisis risk
Link to article:
Authors:
Mundaca, B. Gabriela
Year:
2007
Reference:
Memorandum
Number in series: 4
Summary
We compare the effects of central bank policies, discretionary and commitment, to monitor banks in distress, when possible bailouts are made conditional on the banks’ performance and a bad shock occurring in a future period. Our results are, first, banks exert higher effort and take lower risk under commitment than under discretion. Second, with commitments, the central bank monitors more, but the need for bailing out decreases a great deal in comparison to the discretionary policy. Third, by committing, the problem of multiple equilibria arising under discretion is avoided, and a unique equilibrium, where the incidence of banking crisis is reduced, emerges. The central bank’s ability to commit credibly can be questionable but we show that acting with discretion does not reduce moral hazard problems and banking crisis risk.
JEL:
G21 G28 G38 E58
Keywords:
monitoring, bailouts, banking crises, commitments, conditionality
Project:
Oppdragsgiver: Norges forskningsrådOppdragsgivers prosjektnr.:
Frisch prosjekt: 5111 - Liquidity problems, financing constraints and investment decisions: A theoretical modelling with application to Norway
Contact:
gabriela.mundaca@frisch.uio.no
Financing:
Norwegian Fund for Financial Markets, Norwegian Research Council
