Implicit Subsidies and Regulatory Responses
A very large, internationally connected bank consistently borrows funds at a lower interest rate than smaller, regional banks, even when their underlying investments are equally risky. Market analysts attribute this advantage to a widespread belief that the government would step in to prevent the large bank from collapsing during a financial downturn, but would not do the same for the smaller banks. Based on this scenario, explain the economic problem that gives the large bank this funding advantage. Then, identify one specific type of banking regulation introduced after major financial crises intended to mitigate this problem, and describe its mechanism.
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Economics
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Introduction to Macroeconomics Course
Ch.8 Economic dynamics: Financial and environmental crises - The Economy 2.0 Macroeconomics @ CORE Econ
The Economy 2.0 Macroeconomics @ CORE Econ
CORE Econ
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Analysis in Bloom's Taxonomy
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Implicit Subsidies and Regulatory Responses
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Implicit Subsidies and Regulatory Responses
A key regulatory change following a major financial crisis was to require large banks to hold significantly more of their own capital relative to their assets. From the perspective of addressing the problems created by perceived government bailout guarantees, what is the most direct and effective outcome of this policy?
Following a period of financial instability, a central bank governor announces a new policy. The policy's stated goal is to 'ensure that the potential losses from a large financial institution's failure are absorbed by its private investors and creditors, rather than falling on the public.' This policy is primarily designed to counteract which of the following economic phenomena?
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