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The Design of Government Guarantees for Bank Bonds: Lessons from the Recent Financial Crisis

Author

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  • Aviram Levy
  • Sebastian Schich

Abstract

In 2010 authorities have taken the first steps to end some of the public support measures put in place in response to the financial crisis, starting with government guarantees for bond issues. Financial institutions have made extensive use of this tool, which has been effective in avoiding a further tightening of funding conditions, but this type of public support has, nonetheless, raised some concerns. First, the cost of issuing guaranteed bonds has mainly reflected the characteristics of the sovereign guarantor rather than those of the issuer, thus favouring “weak” borrowers with a “strong” sovereign backing. This situation has the potential to distort competition and create incentives for excessive risk taking. Such effects could have been reduced by the choice of a different fee determination mechanism. Second, the continued availability in 2010 of guarantee schemes, despite a declining overall usage, may be alleviating the pressure on some weak financial institutions to address their weaknesses: the average creditworthiness of banks issuing after mid-2009, when market conditions became more favourable, has sharply declined. JEL Classification: G01, G12, G21, G28. Keywords: financial crisis, policy response to the crisis, government guaranteed bonds, competitive distortions

Suggested Citation

  • Aviram Levy & Sebastian Schich, 2010. "The Design of Government Guarantees for Bank Bonds: Lessons from the Recent Financial Crisis," OECD Journal: Financial Market Trends, OECD Publishing, vol. 2010(1), pages 35-66.
    • Handle: RePEc:oec:dafkad:5km7k9tp8t40
    DOI: 10.1787/fmt-2010-5km7k9tp8t40
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    Citations

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    Cited by:

    1. Cetorelli, Nicola & Goldberg, Linda S., 2012. "Liquidity management of U.S. global banks: Internal capital markets in the great recession," Journal of International Economics, Elsevier, vol. 88(2), pages 299-311.
    2. Eijffinger, Sylvester & Nijskens, Rob, 2012. "A dynamic analysis of bank bailouts and constructive ambiguity," CEPR Discussion Papers 8953, C.E.P.R. Discussion Papers.
    3. Scott E. Page, 2012. "A complexity perspective on institutional design," Politics, Philosophy & Economics, , vol. 11(1), pages 5-25, February.
    4. Eijffinger, Sylvester & Nijskens, Rob, 2011. "Complementing Bagehot: Illiquidity and insolvency resolution," CEPR Discussion Papers 8603, C.E.P.R. Discussion Papers.
    5. Carl Schwartz & Nicholas Tan, 2016. "The Australian Government Guarantee Scheme: 2008–15," RBA Bulletin (Print copy discontinued), Reserve Bank of Australia, pages 39-46, March.
    6. Simon, Claire, 2020. "The Sonderfonds Finanzmarktstabilisierung (SoFFin) Guarantee Scheme (Germany GFC)," Journal of Financial Crises, Yale Program on Financial Stability (YPFS), vol. 2(3), pages 699-714, April.
    7. Sebastian Schich & Arturo Estrella, 2015. "Valuing guaranteed bank debt: Role of strength and size of the bank and the guarantor," Journal of Economic and Financial Studies (JEFS), LAR Center Press, vol. 3(5), pages 19-32, October.
    8. Andrea Cardillo & Andrea Zaghini, 2012. "The recent trends in long-term bank funding," Questioni di Economia e Finanza (Occasional Papers) 137, Bank of Italy, Economic Research and International Relations Area.
    9. Davison, Lee, 2019. "The Temporary Liquidity Guarantee Program: A Systemwide Systemic Risk Exception," Journal of Financial Crises, Yale Program on Financial Stability (YPFS), vol. 1(2), pages 1-39, March.
    10. Simon, Claire, 2020. "Ireland's Credit Institutions (Eligible Liabilities Guarantee) Scheme (Ireland GFC)," Journal of Financial Crises, Yale Program on Financial Stability (YPFS), vol. 2(3), pages 773-792, April.
    11. Jakob Eberl & Christopher Weber, 2014. "ECB Collateral Criteria: A Narrative Database 2001–2013," ifo Working Paper Series 174, ifo Institute - Leibniz Institute for Economic Research at the University of Munich.
    12. König, Philipp & Anand, Kartik & Heinemann, Frank, 2014. "Guarantees, transparency and the interdependency between sovereign and bank default risk," Journal of Banking & Finance, Elsevier, vol. 45(C), pages 321-337.
    13. Metrick, Andrew, 2020. "Bank Debt Guarantee Programs," Journal of Financial Crises, Yale Program on Financial Stability (YPFS), vol. 2(3), pages 71-100, April.
    14. Jakob Korbinian Eberl, 2016. "The Collateral Framework of the Eurosystem and Its Fiscal Implications," ifo Beiträge zur Wirtschaftsforschung, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, number 69.
    15. Engbith, Lily, 2020. "The Dutch Credit Guarantee Scheme (Netherlands GFC)," Journal of Financial Crises, Yale Program on Financial Stability (YPFS), vol. 2(3), pages 809-825, April.
    16. Arturo Estrella & Sebastian Schich, 2012. "Sovereign and Banking Sector Debt: Interconnections through Guarantees," OECD Journal: Financial Market Trends, OECD Publishing, vol. 2011(2), pages 21-45.

    More about this item

    Keywords

    financial crisis; policy response to the crisis; government guaranteed bonds; competitive distortions;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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