Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/187487 
Authors: 
Year of Publication: 
2018
Series/Report no.: 
CFS Working Paper Series No. 612
Publisher: 
Goethe University Frankfurt, Center for Financial Studies (CFS), Frankfurt a. M.
Abstract: 
We examine whether the economy can be insured against banking crises with deposit and loan contracts contingent on macroeconomic shocks. We study banking competition and show that the private sector insures the banking system through such contracts, and banking crises are avoided, provided that failed banks are not bailed out. When risks are large, banks may shift part of them to depositors. In contrast, when banks are bailed out by the next generation, depositors receive non-contingent contracts with high interest rates, while entrepreneurs obtain loan contracts that demand high repayment in good times and low repayment in bad times. As a result, the present generation overinvests, and banks generate large macroeconomic risks for future generations, even if the underlying productivity risk is small or zero. We conclude that a joint policy package of orderly default procedures and contingent contracts is a promising way to reduce the threat of a fragile banking system.
Subjects: 
financial intermediation
macroeconomic risks
state-contingent contracts
banking regulation
JEL: 
D41
E4
G2
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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