Lessons for rescuing a SIFI: The Banque de France’s 1889 ‘lifeboat’
Pierre-Cyrille Hautcoeur, Angelo Riva, Eugene N. White, 2 July 2014
The key challenge for lenders of last resort is to ameliorate financial crises without encouraging excessive risk-taking. This column discusses the lessons from the Banque de France’s successful handling of the crisis of 1889. Recognising its systemic importance, the Banque provided an emergency loan to the insolvent Comptoir d’Escompte. Banks that shared responsibility for the crisis were forced to guarantee the losses, which were ultimately recouped by large fines – notably on the Comptoir’s board of directors. This appears to have reduced moral hazard – there were no financial crises in France for 25 years.
In the aftermath of the 2008 financial crisis, the Dodd-Frank Act of 2010 set out to limit the authority of the Federal Reserve to rescue insolvent financial institutions.
Topics: Economic history, Financial markets
Tags: bailout, bank runs, Banque de France, central banking, Central Banks, financial crises, lender of last resort, moral hazard, SIFIs
Exploring the transmission channels of contagious bank runs
Martin Brown, Stefan Trautmann, Razvan Vlahu, 10 April 2014
Contagious bank runs are an important source of systemic risk. However, with observational data it is near-impossible to disentangle the contagion of bank runs from other potential causes of correlated deposit withdrawals across banks. This column discusses an experimental investigation of the mechanisms behind contagion. The authors find that panic-based deposit withdrawals can be strongly contagious across banks, but only if depositors know that the banks are economically related.
Financial contagion – the situation in which liquidity or insolvency risk is transmitted from one financial institution to another – is viewed by policymakers and academics as a key source of systemic risk in the banking sector.
Topics: Financial markets
Tags: bank runs, banking, banks, contagion, experimental economics, financial crisis, financial stability, global crisis, systemic risk
Theories of financial crises
Itay Goldstein, Assaf Razin, 11 March 2013
Broadly speaking, there are three types of economic crisis: banking crises and panics, credit frictions and market freezes, and currency crises. This column argues that features from these types of crises have been at work and interacted with each other to shape the events of the last few years. From an extensive review of literature on these issues, it’s clear that the biggest challenge policymakers and economists face is in developing integrative models that better describing contemporary economic realities.
Financial and monetary systems are designed to improve the efficiency of real activity and resource allocation. A large empirical literature in financial economics provides evidence connecting financial development to economic growth and efficiency (Levine 1997, Rajan and Zingales 1998).
Topics: Global crisis, Global economy, International finance
Tags: bank runs, Banking crisis, credit frictions, Currency crises, market freezes
Borrower runs: Behavioural motives and their policy implications
Stefan Trautmann, Razvan Vlahu, 28 August 2011
One of the most iconic images from the subprime mortgage crisis in 2007 was the queue of people outside the British bank Northern Rock demanding their deposits back. This column uses experimental evidence to discuss another type of bank run – a borrower run – when mortgage holders strategically default on their loans.
The typical bank run is a “lender run”; lenders and/or depositors take back their money in fear of the bank going bankrupt – and in doing so, make their fears come true. But there is another type of bank run – a “borrower run”.
Topics: Global crisis, International finance
Tags: bank runs, Behavioural economics, borrower runs, strategic default
Deposit insurance without commitment: Wall Street vs. Main Street
Russell Cooper, Hubert Kempf, 18 February 2011
Before the surprising 2007 collapse of Northern Rock, it was taken for granted that bank runs were things of the past. But their return and the modifications of deposit insurance schemes lead many to question the credibility of the government’s commitment. What makes a run on a bank? And when should the government intervene? This column provides some answers.
The events which followed the subprime crisis, which started in August 2007, were shocking news to many economists. Bank runs were back!
Topics: Financial markets, Global crisis, International finance
Tags: bank runs, financial regulation, moral hazard
Contagion through interbank markets
José-Luis Peydró, Rajkamal Iyer, 25 April 2010
How important are financial linkages in transmitting shocks across the financial system? This column examines evidence from India and finds that if a bank has a high level of exposure to another failing bank, the probability that there will be a run on the bank increases by 34 percentage points. This effect is even stronger when the financial system is weak.
How important are financial linkages in transmitting shocks across the financial system? How vulnerable is the financial system to contagion due to its high-degree of financial connections? What are the factors that mitigate the extent of contagion?
Topics: Global crisis, International finance
Tags: bank runs, financial regulation, global crisis, India