The Role of Market Discipline in Handling Problem Banks

Bank of Finland Discussion Paper No. 21/2003

Posted: 17 Feb 2004

See all articles by David T. Llewellyn

David T. Llewellyn

Loughborough University - Department of Economics

David G. Mayes

University of Auckland (Deceased)

Date Written: September 2, 2003

Abstract

This paper considers the conditions that are necessary for market discipline to complement prompt corrective action (PCA) by the authorities in handling problem banks. We initially consider precisely what market discipline means in this context, who exercises it and the preconditions that are necessary for it to operate effectively. We explore the incentives that are necessary for PCA and market discipline to reinforce rather than cancel each other and in particular consider the limits to market discipline in this context from corporate governance and from difficulties in valuation. While our analysis is primarily aimed at advanced countries, we also examine problems in emerging markets and how deposit insurance arrangements might conflict with the aims of both PCA and market discipline.

Keywords: market discipline, banks, prompt corrective action

JEL Classification: G28

Suggested Citation

Llewellyn, David T. and Mayes, David G., The Role of Market Discipline in Handling Problem Banks (September 2, 2003). Bank of Finland Discussion Paper No. 21/2003. Available at SSRN: https://ssrn.com/abstract=501302 or http://dx.doi.org/10.2139/ssrn.501302

David T. Llewellyn (Contact Author)

Loughborough University - Department of Economics ( email )

York House
Loughborough LE11 3TU
Great Britain

David G. Mayes

University of Auckland (Deceased)

Private Bag 92019
Auckland Mail Centre
Auckland, 1142
New Zealand

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