Does Bank Regulation Retard or Contribute to Systemic Risk?

31 Pages Posted: 2 Feb 2001

Date Written: December 2000

Abstract

The prevention of "systemic risk" and a collapse of the banking system is often cited as an objective and rationale for bank regulation and government guarantees, but guarantees and bailouts change the incentives for bank managers and depositors and can lead to an increase in bank failures and losses. Is the net balance favorable, and what might be done to improve it?

The paper distinguishes among three different concepts of how a systemic collapse might occur: a large exogenous shock, a failure of one or a few major banks transmitted by a chain reaction among interconnected institutions, and the failure of one bank providing information causing a reassessment of other similar institutions. A key issue becomes whether market participants do a reasonably accurate job of distinguishing insolvent banks from temporarily illiquid ones; that is an empirical question, and some of the evidence is examined. The final section of the paper looks at ways, for each type of systemic risk, bank supervisors might improve the efficiency of their actions.

JEL Classification: G21

Suggested Citation

Scott, Kenneth E., Does Bank Regulation Retard or Contribute to Systemic Risk? (December 2000). Available at SSRN: https://ssrn.com/abstract=257927 or http://dx.doi.org/10.2139/ssrn.257927

Kenneth E. Scott (Contact Author)

Stanford Law School ( email )

559 Nathan Abbott Way
Stanford, CA 94305-8610
United States
650-723-3070 (Phone)
650-725-0253 (Fax)

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