Implicit and explicit norms and tools of safety net management
China Finance Review International
ISSN: 2044-1398
Article publication date: 19 May 2020
Issue publication date: 18 June 2020
Abstract
Purpose
This paper explains the value of interpreting the design of a country's financial safety net as an exercise in incomplete social contracting.
Design/methodology/approach
Safety net contracts unlucky financial institutions and customers to transfer some or all of what would otherwise be ruinous losses to taxpayers in other sectors. Their capacity to do this is based on a series of unspoken and slowly varying cultural norms that govern when government support is supplied to an insolvent bank, in what forms, on what terms and under what limitations. Identifying these norms is the purpose of this paper. Identifying similarities in the norms that hold sway in the United States and China is the main contribution this paper has to offer.
Findings
Regulators do not want to face the consequences of challenging large insolvent banks' claims that funding problems that their managers know to be hopeless reflect a spate of reversible bad luck and a temporary shortfall in liquidity. In hopes of shifting the problem forward to their successors, regulators forbear from meaningful intervention until and unless crisis-driven depositor runs force them into action.
Research limitations/implications
This means that much like US rescue arrangements, one can demonstrate that the Chinese safety net is incomplete in four ways. It does not fully delineate the events that trigger a loss transfer. It sets formal but imperfectly enforceable limits on the size of potential loss transfers. The political obligations that actually persuade state actors to bail out major banks in a crisis are largely implicit and optional in timing, magnitude and transparency. Finally, the identity of the citizens who will be forced to absorb the costs of crisis bailouts is also optional. Who pays and how they do so will be determined in part during the crisis but will not be finalized until well after the crisis has blown over.
Originality/value
The analysis makes it clear that authorities, express commitment to fair and efficient modes of financial supervision is destined to break down under crisis pressure unless the disadvantaged equity stake that the safety net assigns to taxpayers is rebalanced to record and collect taxpayers' deserved share of the profits a country's megabanks book during booms.
Keywords
Acknowledgements
The Author wishes to Thank The Institute for New Economic Thinking and this Journal for research funding and Robert Dickler, Robert Eisenbeis, Thomas Ferguson, and Larry Wall for helpful comments on earlier drafts of this material.
Citation
Kane, E. (2020), "Implicit and explicit norms and tools of safety net management", China Finance Review International, Vol. 10 No. 3, pp. 229-241. https://doi.org/10.1108/CFRI-12-2019-0163
Publisher
:Emerald Publishing Limited
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