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Managing Risk in the Financial System

Managing Risk in the Financial System

Edited by John Raymond LaBrosse, Rodrigo Olivares-Caminal and Dalvinder Singh

Managing Risk in the Financial System makes important and timely contributions to our knowledge and understanding of banking law, financial institution restructuring and related considerations, through the production of an innovative, international and interdisciplinary set of contributions which link together the law and policy issues surrounding systemic risk and crisis management.

Chapter 3: The Government as Guarantor of Last Resort: Benefits, Costs and the Case for Premium Charges

Sebastian Schich

Subjects: economics and finance, financial economics and regulation, money and banking, law - academic, finance and banking law


1 Sebastian Schich 3.1. INTRODUCTION At the core of the policy apparatus for responding to financial crises is the financial system safety net. That safety net has traditionally been defined as comprising three major elements (or functions) – a lender-oflast-resort, deposit insurance, combined with a regulatory and supervisory framework.2 The array of these three functions is performed by several institutions, typically involving the finance ministry, the central bank, a supervisory agency and a deposit insurance agency. The funding of the safety net is provided in a variety of ways by governments, central banks and fees from regulated firms. Banks will fail and due to the particular nature of their liabilities special resolution regimes are often necessary. In several cases resolution of a problem bank is undertaken by deposit protection agencies under special legislative authorities. Where such regimes exist, it has been shown that involvement of the deposit insurer tends to damp the negative (moral hazard) effect that deposit insurance has on banks’ risk taking.3 Thus, subsuming special bank failure resolution regimes under the deposit insurance function could be justified on the grounds of institutional considerations. In any case, bank failure resolution issues are not part of the focus of the present chapter, although it is noted here that the recent crisis has highlighted once again that the lack of the availability of special resolution tools that allow authorities to wind down failing institutions in a rapid and orderly fashion gives rise to additional costs in a systemic crisis. Governments have a...

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