Edited by John Raymond LaBrosse, Rodrigo Olivares-Caminal and Dalvinder Singh
Chapter 10: Government guarantees and contingent capital: Choosing good shock absorbers
This chapter considers government guarantees in the context of recent experience and proposals for enabling shocks to the banking system to be absorbed without the need for taxpayer-funded bailouts. The chapter argues that guarantees have an important but limited role to play in the financial safety net, when the operation of financial markets is impaired. It argues further that where possible such guarantees should be priced and reflect the costs that financial institutions would have incurred had markets been functioning normally. With interconnected international markets, guarantees offered by one country can have implications for others. For example, when Australia offered guarantees in the spring of 2008, both for wholesale funding and for deposits, New Zealand had little choice but to follow within a day or two. Similarly, when Sweden introduced guarantees for its banks around the same time, after the collapse of Lehman Brothers, this had unintended adverse consequences for the domestic banking system in Latvia, where the authorities could not afford a matching offer.
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