The ‘Celtic Case’: Guarantees, Transparency and Dual Debt Crises
50 Pages Posted: 1 Apr 2013
Date Written: March 30, 2013
Bank liability guarantee schemes have traditionally been viewed as costless measures to shore up investor confidence and stave off bank runs. However, as the experience of some European countries, most notably Ireland, has demonstrated, the credibility and effectiveness of these guarantees is crucially intertwined with the sovereign’s funding risks. Employing methods from the literature on global games, we develop a simple model to explore the functional co-dependence between the rollover risks of a bank and a government, which are connected through the government’s guarantee of bank liabilities. We show the existence and uniqueness of the joint equilibrium and derive its comparative static properties. In solving for the optimal guarantee, we further show that its credibility may be improved through policies that promote balance sheet transparency.
Keywords: bank debt guarantees, transparency, bank default, sovereign default, global games
JEL Classification: G01, G28, D89
Suggested Citation: Suggested Citation