Implicit and explicit norms and tools of safety net management. Issue 3 (17th May 2020)

• Record Type: Journal Article
• Authors: Kane, Edward
• Is Part Of: China finance review international. Volume 10:Issue 3(2020)
• Page Start: 229
• Page End: 241
• Publication Date: 2020-05-17
• Subjects: Social contracts -- Crisis management -- Financial safety nets -- Central-bank norms -- Incomplete contracting -- Taxpayers equity stake in too-big-to-fail banks; Finance -- China -- Periodicals; Investments, Foreign -- China -- Periodicals; China -- Economic policy -- Periodicals; 332.095105
• DOI: 10.1108/CFRI-12-2019-0163
• Languages: English
• ISSNs: 2044-1398

Abstract

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.