Moral hazard and government guarantees in the banking industry
Title: Moral hazard and government guarantees in the banking industry
Citation: Journal of financial regulation, 2015, Vol. 1, No. 1, pp. 30-50
ISSN: 2053-4833; 2053-4841
The massive use of public funds in the financial sector and the large costs for taxpayers are often used to justify the idea that public intervention should be limited. This conclusion is based on the idea that government guarantees always induce financial institutions to take excessive risk. In this article, we challenge this conventional view and argue that it relies on some specific assumptions made in the existing literature on government guarantees and on a number of modelling choices. We review the theory of government guarantees by highlighting and discussing the role that these underlying assumptions play in the assessment of the desirability and effectiveness of government guarantees and propose a new framework for thinking about them.
First published online: 3 February 2015
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