Working Paper: CEPR ID: DP9508
Authors: Alan Morrison; Lucy White
Abstract: Existing studies suggest that systemic crises may arise because banks either hold correlated assets, or are connected by interbank lending. This paper shows that common regulation is also a conduit for interbank contagion. One bank?s failure may undermine confidence in the banking regulator?s competence, and, hence, in other banks chartered by the same regulator. As a result, depositors withdraw funds from otherwise unconnected banks. The optimal regulatory response to this behaviour can be privately to exhibit forbearance to a failing bank. We show that regulatory transparency improves confidence ex ante but impedes regulators? ability to stem panics ex post.
Keywords: bank regulation; contagion; reputation
JEL Codes: G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Bank's failure (G21) | Loss of depositor confidence in regulator (G28) |
| Loss of depositor confidence in regulator (G28) | Withdrawals from other banks (G21) |
| Bank's failure (G21) | Withdrawals from other banks (G21) |
| Regulator's initial reputation (G18) | Loss of depositor confidence in regulator (G28) |
| Regulator's initial reputation (G18) | Withdrawals from other banks (G21) |
| Regulatory forbearance (G28) | Manage regulator's reputation (G18) |