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Financial Institutions, Financial Contagion, and Financial Crises

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  • Haizhou Huang

    (International Monetery Fund)

Abstract

Financial crises are endogenized through institutions related to the corporate sector and the interbank market. Financial crises can emanate from financial institutions which determines the nature of equilibrium in the interbank market. In a pooling equilibrium all illiquid banks are treated in the same manner in the interbank market. With private information about one's own solvency, best illiquid banks will not borrow but rather liquidate some premature assets. The withdrawal of the best banks from the interbank market will generate negative externalities in the interbank market. Consequently, the quality of the interbank market will decline - which will make more solvent but illiquid banks withdraw from the market -- and the quality of market deteriorates further. A cycle of this process leads to a collapse of the interbank market. However, in a separating equilibrium solvent and insolvent banks are distinguishable in the interbank market, bank runs are isolated to illiquid and insolvent banks, and a bank run contagion will never occur in such an economy.

Suggested Citation

  • Haizhou Huang, 2000. "Financial Institutions, Financial Contagion, and Financial Crises," Econometric Society World Congress 2000 Contributed Papers 1595, Econometric Society.
    • Handle: RePEc:ecm:wc2000:1595
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    References listed on IDEAS

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    3. Piersanti, Giovanni, 2012. "The Macroeconomic Theory of Exchange Rate Crises," OUP Catalogue, Oxford University Press, number 9780199653126.
    4. Eric Santor, 2003. "Crisis bancarias y contagio: evidencia empírica," Monetaria, CEMLA, vol. 0(3), pages 293-344, julio-sep.
    5. Julien Reynaud & Rofikoh Rokhim, 2005. "Do banking crises enhance efficiency? A case study of 1994 Turkish and 1997 Indonesian crises," Cahiers de la Maison des Sciences Economiques bla05007, Université Panthéon-Sorbonne (Paris 1).
    6. Pistor Katharina, 2012. "Governing Interdependent Financial Systems: Lessons from the Vienna Initiative," Journal of Globalization and Development, De Gruyter, vol. 2(2), pages 1-25, January.
    7. Emilio Colombo & Akos Valentinyi, 2002. "Subsidies, Soft Budget Constraints and Financial Market Imperfections," Working Papers 50, University of Milano-Bicocca, Department of Economics, revised Feb 2002.
    8. Caramazza, Francesco & Ricci, Luca & Salgado, Ranil, 2004. "International financial contagion in currency crises," Journal of International Money and Finance, Elsevier, vol. 23(1), pages 51-70, February.
    9. Nan-Kuang Chen & Hsiao-Lei Chu, 2003. "Collateral Value and Forbearance Lending," CEP Discussion Papers dp0603, Centre for Economic Performance, LSE.
    10. Mehrdad Vahabi, 2021. "Introduction: a special issue in honoring Janos Kornai," Public Choice, Springer, vol. 187(1), pages 1-13, April.
    11. Raphael Solomon, 2005. "Pocket Banks and Out-of-Pocket Losses: Links between Corruption and Contagion," Staff Working Papers 05-23, Bank of Canada.
    12. Eric Santor, 2003. "Banking Crises and Contagion: Empirical Evidence," Staff Working Papers 03-1, Bank of Canada.
    13. Goodhart, Charles A.E. & Huang, Haizhou, 2005. "The lender of last resort," Journal of Banking & Finance, Elsevier, vol. 29(5), pages 1059-1082, May.
    14. Veysov, Alexander & Stolbov, Mikhail, 2011. "The impact of financial sector on innovation activity: theoretical background and new evidence from russian banking sector," MPRA Paper 38747, University Library of Munich, Germany.
    15. Rodica Sandu-Loisel, 2007. "Hardened Budget Constraints in Romania: An Approach by CGE Modeling," Post-Communist Economies, Taylor & Francis Journals, vol. 19(1), pages 93-115.
    16. Coudert, Virginie & Gex, Mathieu, 2010. "Contagion inside the credit default swaps market: The case of the GM and Ford crisis in 2005," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 20(2), pages 109-134, April.
    17. Jiahua Che, 2000. "Decentralized Financing, Centralized Financing and the Dual Track System: Toward a New Theory of Soft Budget Constraints," William Davidson Institute Working Papers Series 261, William Davidson Institute at the University of Michigan.
    18. Raphael Solomon, 2004. "When Bad Things Happen to Good Banks: Contagious Bank Runs and Currency Crises," Staff Working Papers 04-18, Bank of Canada.
    19. Xu, Cheng-Gang & Maskin, Eric, 2001. "Soft Budget Constraint Theories: From Centralization to the Market," CEPR Discussion Papers 2715, C.E.P.R. Discussion Papers.

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    More about this item

    JEL classification:

    • D20 - Microeconomics - - Production and Organizations - - - General
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • P50 - Political Economy and Comparative Economic Systems - - Comparative Economic Systems - - - General

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