Policies for Banking Crises: A Theoretical Framework

This Paper analyses the effects on ex ante risk-shifting incentives and ex post fiscal costs of three policies that are frequently used in dealing with banking crises, namely, forbearance from prudential regulations, extension of blanket deposit guarantees, and provision of unrestricted liquidity support. In the context of a simple model of information-based bank runs, where banks are funded with both insured and uninsured deposits, the paper shows that the expectation of implementation of any of these policies leads to a reduction in the interest rate of uninsured deposits and in the bank’s incentives to take risk, but increases the expected fiscal costs of the crises.