Edited by John Raymond LaBrosse, Rodrigo Olivares-Caminal and Dalvinder Singh
Chapter 12: The impact of sovereign guarantees on the quality of bank debt: Theory and evidence from Europe
The financial crisis has put a sharp spotlight on the use of government supported guarantees as a policy tool to support financial stability. Together with the provision by some public authorities of additional capital and by central banks of additional liquidity for banks, these measures meant that the sovereign effectively provided the function of the ‘guarantor of last resort’ in response to the banking crisis of 2008–09. The immediate concern was financial stability and these policies were helpful in stabilizing markets and institutions. That said, guarantees – even if not triggered – are not costless. For the guarantor, they create contingent liabilities and underpriced guarantees can create fiscal challenges further down the road and lead to distortions to competition and incentives and produce moral hazard. While many of the explicit emergency guarantees have been withdrawn already, recent tensions in funding markets have led to renewed calls for the creation of explicit government-supported arrangements for guaranteeing debt.
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