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

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Abstract

This paper presents an intuitive and analytical model of how the federal safety net affects banks' cost of funds. Emphasis is placed on distinguishing between fixed and marginal costs in banking and on the implications of the model for measuring the subsidy. Empirical results strongly suggest that the safety net has benefitted banks and that over recent years bank holding companies have tended to move activities into a bank or a bank subsidiary. We conclude that limiting extension of the safety net subsidy should be a serious concern when designing strategies for expanding bank activities.
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  • Myron L. Kwast & Wayne Passmore, 1998. "The subsidy provided by the federal safety net: theory, measurement, and containment," Proceedings 599, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhpr:599
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    1. Kathleen A. Kuester & James M. O'Brien, 1990. "Market-based deposit insurance premiums," Proceedings 264, Federal Reserve Bank of Chicago.
    2. Boyd, John H. & Graham, Stanley L. & Hewitt, R. Shawn, 1993. "Bank holding company mergers with nonbank financial firms: Effects on the risk of failure," Journal of Banking & Finance, Elsevier, vol. 17(1), pages 43-63, February.
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    Cited by:

    1. 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.
    2. 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.
    3. 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.
    4. Myron Kwast & S. Passmore, 1999. "The Subsidy Provided by the Federal Safety Net: Theory and Evidence," Journal of Financial Services Research, Springer;Western Finance Association, vol. 16(2), pages 125-145, December.
    5. Arnoud Boot & Silva Dezõelan & Todd Milbourn, 1999. "Regulatory Distortions in a Competitive Financial Services Industry," Journal of Financial Services Research, Springer;Western Finance Association, vol. 16(2), pages 249-259, December.
    6. Douglas D. Evanoff & Larry D. Wall, 2000. "Subordinated debt and bank capital reform," Working Paper Series WP-00-7, Federal Reserve Bank of Chicago.
    7. Marvin Goodfriend & Jeffrey M. Lacker, 1999. "Limited commitment and central bank lending," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-27.
    8. Gary Whalen, 1999. "Trends in Organizational Form and their Relationship to Performance: The Case of Foreign Securities Subsidiaries of U.S. Banking Organizations," Journal of Financial Services Research, Springer;Western Finance Association, vol. 16(2), pages 181-218, December.

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