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The subsidy provided by the federal safety net: theory and measurement

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Abstract

Views about the value to depository institutions of the federal safety net differ widely. Resolution of the issue is important because defining the appropriate relationship between the federal safety net and financial institutions is central to the design of efficient financial modernization strategies. A model is presented of how the safety net subsidy affects the size of the banking system and the behavior of banks. The model suggests that banks should have lower capital ratios than similar nonbank financial firms. Evidence is presented that supports this prediction, and that banks have organized themselves in ways that take maximum advantage of safety net benefits.

Suggested Citation

  • Myron L. Kwast & Wayne Passmore, 1998. "The subsidy provided by the federal safety net: theory and measurement," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
    • Handle: RePEc:fip:fedfpr:y:1998:i:sep:x:3
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    Cited by:

    1. Andreas Lehnert & Wayne Passmore, 1999. "The banking industry and the safety net subsidy," Finance and Economics Discussion Series 1999-34, Board of Governors of the Federal Reserve System (U.S.).
    2. Mingo, John J., 2000. "Policy implications of the Federal Reserve study of credit risk models at major US banking institutions," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 15-33, January.
    3. Berger, Allen N. & Demsetz, Rebecca S. & Strahan, Philip E., 1999. "The consolidation of the financial services industry: Causes, consequences, and implications for the future," Journal of Banking & Finance, Elsevier, vol. 23(2-4), pages 135-194, February.
    4. Allen, Linda & Jagtiani, Julapa, 2000. "The risk effects of combining banking, securities, and insurance activities," Journal of Economics and Business, Elsevier, vol. 52(6), pages 485-497.

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