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Monitoring, liquidity provision and financial crisis risk
By Mundaca, B. Gabriela
Memorandum 4/2007
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Abstract |
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 Classification:
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G21 G28 G38 E58 |
| Keywords:
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monitoring, bailouts,
banking crises, commitments, conditionality |
| Project:
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5111 Liquidity problems, financing constraints and investment decisions: A theoretical modelling with application to Norway
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| Financing:
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Norwegian Fund for Financial Markets, Norwegian
Research Council |
| Contact:
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gabriela.mundaca@frisch.uio.no |
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[Full Text PDF]
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