Taneli Mäkinen, Lucio Sarno, Gabriele Zinna, 11 September 2019

During the recent financial crises, government guarantees helped reduce the funding costs of banks by providing them with insurance, thus curbing panic in banking systems and financial markets. This column argues, however, that these beneficial effects can be attenuated when guarantees are risky in the sense that they offer weaker protection in recessions, when the guarantor is more vulnerable, or the guarantees are less certain. Using a large international panel of banks, a significant risk premium is found to be associated with implicit government guarantees.

Franklin Allen, Elena Carletti, Itay Goldstein, Agnese Leonello, 26 April 2015

Government guarantees to financial institutions are intended to reduce the likelihood of runs and bank failures, but are also usually associated with distortions in banks’ risk taking decisions. We build a model to analyze these trade-offs based on the global-games literature and its application to bank runs. We derive several results, some of which against common wisdom. First, guarantees reduce the probability of a run, taking as given the amount of bank risk taking, but lead banks to take more risk, which in turn might lead to an increase in the probability of a run. Second, guarantees against fundamental-based failures and panic-based runs may lead to more efficiency than guarantees against panic-based runs alone. Finally, there are cases where following the introduction of guarantees banks take less risk than would be optimal.

Aviram Levy, Fabio Panetta, 03 November 2009

In December 2009, government guarantees on the issuance of bank bonds will close to new issuance in many EU countries. This column argues that the guarantees have been effective and should be extended into 2010, despite improved market conditions and bank profitability. In doing so, governments should correct the schemes for some distortionary effects and develop a careful exit strategy.

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