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Laeven and Valencia, The Use of Blanket Guarantees in Banking Crises

Laeven and Valencia, The Use of Blanket Guarantees in Banking Crises

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In episodes of significant banking distress or perceived systemic risk to the financial system,
policymakers have often opted for issuing blanket guarantees on bank liabilities to stop or
avoid widespread bank runs. In theory, blanket guarantees can prevent bank runs if they are
credible. However, guarantee could add substantial fiscal costs to bank restructuring programs and may increase moral hazard going forward. Using a sample of 42 episodes of banking crises, this paper finds that blanket guarantees are successful in reducing liquidity pressures on banks arising from deposit withdrawals. However, banks’ foreign liabilities appear virtually irresponsive to blanket guarantees. Furthermore, guarantees tend to be fiscally costly, though this positive association arises in large part because guarantees tend to be employed in conjunction with extensive liquidity support and when crises are severe.
In episodes of significant banking distress or perceived systemic risk to the financial system,
policymakers have often opted for issuing blanket guarantees on bank liabilities to stop or
avoid widespread bank runs. In theory, blanket guarantees can prevent bank runs if they are
credible. However, guarantee could add substantial fiscal costs to bank restructuring programs and may increase moral hazard going forward. Using a sample of 42 episodes of banking crises, this paper finds that blanket guarantees are successful in reducing liquidity pressures on banks arising from deposit withdrawals. However, banks’ foreign liabilities appear virtually irresponsive to blanket guarantees. Furthermore, guarantees tend to be fiscally costly, though this positive association arises in large part because guarantees tend to be employed in conjunction with extensive liquidity support and when crises are severe.

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Published by: Muhammad Arief Billah on Nov 25, 2008
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06/14/2009

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WP/08/
250
 
The Use of Blanket Guarantees inBanking Crises
 Luc Laeven and Fabian Valencia
 
 
 
 
© 2008 International Monetary Fund WP/08/
250
 
IMF Working Paper
Research Department
The Use of Blanket Guarantees in Banking CrisesPrepared by Luc Laeven and Fabian Valencia
1
 
Authorized for distribution by Stijn ClaessensOctober 2008
Abstract
 
This Working Paper should not be reported as representing the views of the IMF.
 
The views expressed in this Working Paper are those of the author(s) and do not necessarily representthose of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.
 In episodes of significant banking distress or perceived systemic risk to the financial system, policymakers have often opted for issuing blanket guarantees on bank liabilities to stop or avoid widespread bank runs. In theory, blanket guarantees can prevent bank runs if they arecredible. However, guarantee could add substantial fiscal costs to bank restructuring programs and may increase moral hazard going forward. Using a sample of 42 episodes of  banking crises, this paper finds that blanket guarantees are successful in reducing liquidity pressures on banks arising from deposit withdrawals. However, banks’ foreign liabilitiesappear virtually irresponsive to blanket guarantees. Furthermore, guarantees tend to befiscally costly, though this positive association arises in large part because guarantees tend to be employed in conjunction with extensive liquidity support and when crises are severe.JEL Classification Numbers: G21, G28Keywords: banking crisis, crisis resolution, blanket guarantee, moral hazardAuthor 
s E-Mail Address:LLaeven@imf.org,Fvalencia@imf.org 
1
Laeven is affiliated with the International Monetary Fund (IMF) and the Center for Economic Policy Research(CEPR) and Valencia is affiliated with the IMF. The authors thank Gustavo Adler, Eugenio Cerutti, Nigel Chalk,Stijn Claessens, Luis Cortavarría-Checkley, Augusto De La Torre, Giovanni dell’Ariccia, Peter Doyle, DavidHoelscher, Simon Johnson, Daniel Leigh, Ashoka Mody, Jonathan Ostry, and Alison Stuart for comments anddiscussions.

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