On the economics of crisis contracts

  • We examine the impact of so-called "Crisis Contracts" on bank managers' risk-taking incentives and on the probability of banking crises. Under a Crisis Contract, managers are required to contribute a pre-specified share of their past earnings to finance public rescue funds when a crisis occurs. This can be viewed as a retroactive tax that is levied only when a crisis occurs and that leads to a form of collective liability for bank managers. We develop a game-theoretic model of a banking sector whose shareholders have limited liability, so that society at large will suffer losses if a crisis occurs. Without Crisis Contracts, the managers' and shareholders' interests are aligned, and managers take more than the socially optimal level of risk. We investigate how the introduction of Crisis Contracts changes the equilibrium level of risk-taking and the remuneration of bank managers. We establish conditions under which the introduction of Crisis Contracts will reduce the probability of a banking crisis and improve social welfare. We explore how Crisis Contracts and capital requirements can supplement each other and we show that the efficacy of Crisis Contracts is not undermined by attempts to hedge.

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Metadaten
Author:Elias Aptus, Volker Britz, Hans Gersbach
URN:urn:nbn:de:hebis:30:3-338301
URL:https://www.ifk-cfs.de/2385.html
Parent Title (German):Center for Financial Studies (Frankfurt am Main): CFS working paper series ; No. 453
Series (Serial Number):CFS working paper series (453)
Publisher:Center for Financial Studies
Place of publication:Frankfurt, M.
Document Type:Working Paper
Language:English
Year of Completion:2014
Date of first Publication:2014/03/24
Publishing Institution:Universit├Ątsbibliothek Johann Christian Senckenberg
Release Date:2014/05/28
Tag:Capital requirements
Banker's pay; Banking crisis; Crisis contracts; Excessive risk taking; Hedging
Page Number:51
HeBIS-PPN:349979308
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
Sammlungen:Universit├Ątspublikationen
Licence (German):License LogoDeutsches Urheberrecht