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Monitoring, liquidity provision and financial crisis risk

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Forfattere:

Mundaca, B. Gabriela

År:

2007

Referanse:

Memorandum
Nummer i serie: 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.

Nøkkelord:

monitoring, bailouts, banking crises, commitments, conditionality

JEL:

G21 G28 G38 E58

Prosjekt info:

Oppdragsgiver: Norges forskningsråd
Oppdragsgivers prosjektnr.:
Frisch prosjekt: 5111 - Liquidity problems, financing constraints and investment decisions: A theoretical modelling with application to Norway

Kontakt:

gabriela.mundaca@frisch.uio.no

Finansiering:

Norwegian Fund for Financial Markets, Norwegian Research Council