Banking with Contingent Contracts, Macroeconomic Risks, and Banking Crises

CER-ETH - Center of Economic Research at ETH Zurich, Working Paper No. 08/93

37 Pages Posted: 22 Sep 2008

See all articles by Hans Gersbach

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Date Written: August 2008

Abstract

We examine banking competition when deposit or loan contracts contingent on macroeconomic shocks become feasible. We show that the risk allocation is efficient, provided that banks are not bailed out. In this case, banks may shift part of the risk to depositors. The private sector insures the banking sector and banking crises are avoided. In contrast, when banks are bailed out, depositors receive non-contingent contracts with high interest rates, while entrepreneurs obtain loan contracts that demand high repayment in good times and low repayment in bad times. As a result, the present generation overinvests, and banks create large macroeconomic risks for future generations, even if the underlying risk is small or zero.

Keywords: Financial intermediation, macroeconomic risks, state contingent contracts, banking regulation

JEL Classification: D41, E4, G2

Suggested Citation

Gersbach, Hans, Banking with Contingent Contracts, Macroeconomic Risks, and Banking Crises (August 2008). CER-ETH - Center of Economic Research at ETH Zurich, Working Paper No. 08/93. Available at SSRN: https://ssrn.com/abstract=1271872 or http://dx.doi.org/10.2139/ssrn.1271872

Hans Gersbach (Contact Author)

ETH Zurich - CER-ETH -Center of Economic Reseaarch ( email )

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IZA Institute of Labor Economics

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Germany

CESifo (Center for Economic Studies and Ifo Institute)

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Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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