On the Causes of Overlending: Are Guarantees on Deposits the Culprit?

34 Pages Posted: 7 Nov 2003

See all articles by Mariassunta Giannetti

Mariassunta Giannetti

Stockholm School of Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Swedish House of Finance

Date Written: September 2003

Abstract

Conventional wisdom holds that overlending problems and banking crises in open economies are provoked by investor moral hazard, which is caused in turn by guarantees on deposits. This Paper shows that this is not necessarily the case: guarantees on deposits may even limit the losses banks accumulate. In the model, banks may rationally accumulate bad loans if international investors have incomplete information on firm profitability and initially provide funds at low cost. In equilibrium, international investors rationally require a risk premium and banks stop renewing bad loans, only when a substantial amount of losses has been accumulated. This feature of the equilibrium does not depend on whether or not there are guarantees on deposits. Transparency and bond market development can eliminate overlending problems and prevent banking crises.

Keywords: Banking crises, bank-firm relationships, guarantees on deposits, transparency, bond markets

JEL Classification: F34, G21, G28

Suggested Citation

Giannetti, Mariassunta, On the Causes of Overlending: Are Guarantees on Deposits the Culprit? (September 2003 ). CEPR Discussion Paper No. 4055. Available at SSRN: https://ssrn.com/abstract=466262

Mariassunta Giannetti (Contact Author)

Stockholm School of Economics ( email )

P.O. Box 6501
Sveavagen 65
SE-113 83 Stockholm
Sweden
+46 8 736 9607 (Phone)
+46 8 312 327 (Fax)

HOME PAGE: http://sites.google.com/site/mariassuntagiannetti/Home

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

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