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Why Are There So Many Banking Crises?

Why Are There So Many Banking Crises?: The Politics and Policy of Bank Regulation

Jean-Charles Rochet
Copyright Date: 2008
Pages: 336
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  • Book Info
    Why Are There So Many Banking Crises?
    Book Description:

    Almost every country in the world has sophisticated systems to prevent banking crises. Yet such crises--and the massive financial and social damage they can cause--remain common throughout the world. Does deposit insurance encourage depositors and bankers to take excessive risks? Are banking regulations poorly designed? Or are banking regulators incompetent? Jean-Charles Rochet, one of the world's leading authorities on banking regulation, argues that the answer in each case is "no." InWhy Are There So Many Banking Crises?, he makes the case that, although many banking crises are precipitated by financial deregulation and globalization, political interference often causes--and almost always exacerbates--banking crises. If, for example, political authorities are allowed to pressure banking regulators into bailing out banks that should be allowed to fail, then regulation will lack credibility and market discipline won't work. Only by insuring the independence of banking regulators, Rochet says, can market forces work and banking crises be prevented and minimized. In this important collection of essays, Rochet examines the causes of banking crises around the world in recent decades, focusing on the lender of last resort; prudential regulation and the management of risk; and solvency regulations. His proposals for reforms that could limit the frequency and severity of banking crises should interest a wide range of academic economists and those working for central and private banks and financial services authorities.

    eISBN: 978-1-4008-2831-9
    Subjects: Political Science, Law

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-viii)
  3. Preface and Acknowledgments
    (pp. ix-xii)
  4. General Introduction and Outline of the Book
    (pp. 1-18)

    The recent episode of the Northern Rock bank panic in the United Kingdom, with depositors queuing from 4 a.m. in order to get their money out, reminds us that banking crises are a recurrent phenomenon. An interesting IMF study back in 1997 identified 112 systemic banking crises in 93 countries and 51 borderline crises in 46 countries between 1975 and 1995, including the Savings and Loan crisis in the United States in the late 1980s, which cost more than $150 billion to the American taxpayers. Since then, Argentina, Russia, Indonesia, Turkey, South Korea, and many other countries have also experienced...

  5. Chapter One Why Are There So Many Banking Crises?
    (pp. 21-34)
    Jean-Charles Rochet

    The last thirty years have seen an impressive number of banking and financial crises all over the world. In an interesting study, Caprio and Klingebiel (1997) identify 112 systemic banking crises in 93 countries and 51 borderline crises in 46 countries since the late 1970s (see also Lindgren et al. 1996). More than 130 out of 180 of the IMF countries have thus experienced crises or serious banking problems. Similarly, the cost of the Savings and Loan crisis in the United States in the late 1980s has been estimated as over USD 150 billion, which is more than the cumulative...

  6. Chapter Two Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All?
    (pp. 37-70)
    Jean-Charles Rochet and Xavier Vives

    There have been several recent controversies about the need for a lender of last resort (LLR) both within national banking systems (the central banks) and at an international level (the IMF).¹ The concept of an LLR was elaborated in the nineteenth century by Thornton (1802) and Bagehot (1873). An essential point of the “classical” doctrine associated with Bagehot asserts that the LLR role is to lend to “solvent but illiquid” banks under certain conditions.²

    Banking crises have been recurrent in most financial systems. The LLR facility and deposit insurance were instituted precisely to provide stability to the banking system and...

  7. Chapter Three The Lender of Last Resort: A Twenty-First-Century Approach
    (pp. 71-102)
    Xavier Freixas, Bruno M. Parigi and Jean-Charles Rochet

    This paper offers a new perspective on the role of emergency liquidity assistance (ELA) by the central bank (CB), often referred to as the lender of last resort (LLR). We take into account two well-acknowledged facts of the banking industry: first, that it is difficult to disentangle liquidity shocks from solvency shocks; second, that moral hazard and gambling for resurrection are typical behaviors for banks experiencing financial distress.

    The LLR policy has a long history. Bagehot’s (1873) “classical” view maintained that the LLR policy should satisfy at least three conditions: (i) lending should be open only to solvent institutions and...

  8. Chapter Four Macroeconomic Shocks and Banking Supervision
    (pp. 105-125)
    Jean-Charles Rochet

    The spectacular banking crises that many countries have experienced in the last twenty years (see, for example, Lindgren et al. (1996) for a list) have led several bankers, politicians, and economists to advocate increasing the pressure of market discipline on banks, as a complement to prudential regulation and supervision. They argue that the increased complexity of financial markets and banking activities have made traditional centralized regulation insufficient, either because it is too crude (like the Basel Accords of 1988) or too complex to be applicable (like the standardized approach proposed by the Basel Committee to account for market risks in...

  9. Chapter Five Interbank Lending and Systemic Risk
    (pp. 126-158)
    Jean-Charles Rochet and Jean Tirole

    Systemic risk refers to the propagation of an agent’s economic distress to other agents linked to that agent through financial transactions. Systemic risk is a serious concern in manufacturing, where trade credit links producers through a chain of obligations,¹ and in the insurance industry through the institution of reinsurance. The anxiety about systemic risk is perhaps strongest among bank executives and regulators. For, banks’ mutual claims, which, by abuse of terminology, we will gather under the generic name of “interbank loans” or “interbank transactions,” have grown substantially in recent years. These include intraday debits on payment systems, overnight and term...

  10. Chapter Six Controlling Risk in Payment Systems
    (pp. 159-194)
    Jean-Charles Rochet and Jean Tirole

    Over the past twenty years the growing integration of financial markets, the development of new financial instruments, and the advance of computer technology have all contributed to a remarkable growth of financial activity in the main industrialized countries. One of the most significant consequences of this growth has been the unprecedented increase in the volume of trade on the large-value interbank payment systems (see table 6.1), which itself has resulted in a massive increase in intraday overdrafts on those systems (see table 6.2).

    The central banks of the large industrialized countries, concerned with the risks that this growth was creating...

  11. Chapter Seven Systemic Risk, Interbank Relations, and the Central Bank
    (pp. 195-224)
    Xavier Freixas, Bruno M. Parigi and Jean-Charles Rochet

    The possibility of a systemic crisis affecting the major financial markets has raised regulatory concern all over the world. Whatever the origin of a financial crisis, it is the responsibility of the regulatory body to provide adequate fire walls for the crisis not to spill over to other institutions. In this paper we explore the possibilities of contagion from one institution to another that can stem from the existence of a network of financial contracts. These contracts are essentially generated from three types of operations: the payments system, the interbank market, and the market for derivatives.¹ Since these contracts are...

  12. Chapter Eight Capital Requirements and the Behavior of Commercial Banks
    (pp. 227-257)
    Jean-Charles Rochet

    This paper is motivated by the adoption at the European Community level of a new capital requirement for commercial banks. This reform (fully effective from January 1993) is in fact closely inspired by a similar regulation (the so-called Cooke ratio) adopted earlier (December 1987) by the Bank of International Settlements.

    I try to examine here what economic theory can tell us about such regulations, and more specifically:

    Why do they exist in the first place?

    Are they indeed a good way to limit the risk of failure of commercial banks?

    What effects can be expected on the behavior of these...

  13. Chapter Nine Rebalancing the Three Pillars of Basel II
    (pp. 258-280)
    Jean-Charles Rochet

    The ongoing reform of the Basel Accord is supposed to rely on three “pillars”: a new capital ratio, supervisory review, and market discipline. But even a cursory look at the proposals of the Basel Committee on Banking Supervision reveals a certain degree of imbalance between these three pillars. Indeed, the Basel Committee (2003) gives a lot of attention (132 pages) to the refinements of the risk weights in the new capital ratio, but it is much less precise about the other pillars (16 pages on pillar 2 and 15 pages on pillar 3).¹

    Even though the initial capital ratio (Basel...

  14. Chapter Ten The Three Pillars of Basel II: Optimizing the Mix
    (pp. 281-308)
    Jean-Paul Décamps, Jean-Charles Rochet and Benoît Roger

    The ongoing reform of the Basel Accord¹ relies on three “pillars”: capital adequacy requirements, supervisory review, and market discipline. Yet the articulation of how these three instruments are to be used in concert is far from clear. On the one hand, the recourse to market discipline is rightly justified by common-sense arguments about the increasing complexity of banking activities, and the impossibility for banking supervisors to monitor these activities in detail. It is therefore legitimate to encourage monitoring of banks by professional investors and financial analysts as a complement to banking supervision. Similarly, a notion of gradualism in regulatory intervention...