Contents
Preface and Acknowledgments ix
General Introduction and Outline of the Book 1
References 14
PART 1. WHY ARE THERE SO MANY BANKING CRISES? 19
Chapter 1. Why Are there So Many Banking Crises?
Jean-Charles Rochet 21
1.1 Introduction 21
1.2 The Sources of Banking Fragility 23
1.3 The Lender of Last Resort 24
1.4 Deposit Insurance and Solvency Regulations 27
1.5 Lessons from Recent Crises 28
1.6 The Future of Banking Supervision 30
References 33
PART 2. THE LENDER OF LAST RESORT 35
Chapter 2. Coordination Failures and the Lender of Last Resort:
Was Bagehot Right After All?
Jean-Charles Rochet and Xavier Vives 37
2.1 Introduction 37
2.2 The Model 41
2.3 Runs and Solvency 44
2.4 Equilibrium of the Investors’ Game 47
2.5 Coordination Failure and Prudential Regulation 54
2.6 Coordination Failure and LLR Policy 56
2.7 Endogenizing the Liability Structure and Crisis Resolution 59
2.8 An International LLR 63
2.9 Concluding Remarks 66
References 67
Chapter 3. The Lender of Last Resort: A 21st-Century Approach
Xavier Freixas, Bruno M. Parigi, and Jean-Charles Rochet 71
vi CONTENTS
3.1 Introduction 71
3.2 The Model 75
3.3 Efficient Supervision: Detection and Closure of Insolvent Banks 81
3.4 Efficient Closure 85
3.5 Central Bank Lending 89
3.6 Efficient Allocation in the Presence of Gambling for Resurrection 95
3.7 Policy Implications and Conclusions 97
3.8 Appendix 99
References 102
PART 3. PRUDENTIAL REGULATION AND THE
MANAGEMENT OF SYSTEMIC RISK 105
Chapter 4. Macroeconomic Shocks and Banking Supervision
Jean-Charles Rochet 107
4.1 Introduction 107
4.2 A Brief Survey of the Literature 108
4.3 A Simple Model of Prudential Regulation without
Macroeconomic Shocks 110
4.4 How to Deal with Macroeconomic Shocks? 114
4.5 Is Market Discipline Useful? 120
4.6 Policy Recommendations for Macroprudential Regulation 123
References 124
Chapter 5. Interbank Lending and Systemic Risk
Jean-Charles Rochet and Jean Tirole 128
5.1 Benchmark: No Interbank Lending 134
5.2 Date-0 Monitoring and Optimal Interbank Loans 141
5.3 Date-1 Monitoring, Too Big to Fail, and Bank Failure Propagations 150
5.4 Conclusion 156
5.5 Appendix: Solution of Program (P) 157
References 159
Chapter 6. Controlling Risk in Payment Systems
Jean-Charles Rochet and Jean Tirole 161
6.1 Taxonomy of Payment Systems 163
6.2 Three Illustrations 169
6.3 An Economic Approach to Payment Systems 175
6.4 Centralization versus Decentralization 183
6.5 An Analytical Framework 186
6.6 Conclusion 193
References 194
Chapter 7. Systemic Risk, Interbank Relations, and Liquidity Provision
by the Central Bank
Xavier Freixas, Bruno M. Parigi, and Jean-Charles Rochet 197
CONTENTS vii
7.1 The Model 201
7.2 Pure Coordination Problems 207
7.3 Resiliency and Market Discipline in the Interbank System 209
7.4 Closure-Triggered Contagion Risk 212
7.5 Too-Big-to-Fail and Money Center Banks 215
7.6 Discussions and Conclusions 217
7.7 Appendix: Proof of Proposition 7.1 219
References 224
PART 4. SOLVENCY REGULATIONS 227
Chapter 8. Capital Requirements and the Behavior of Commercial Banks
Jean-Charles Rochet 229
8.1 Introduction 229
8.2 The Model 232
8.3 The Behavior of Banks in the Complete Markets Setup 233
8.4 The Portfolio Model 240
8.5 The Behavior of Banks in the Portfolio Model without Capital
Requirements 242
8.6 Introducing Capital Requirements in the Portfolio Model 246
8.7 Introducing Limited Liability in the Portfolio Model 248
8.8 Conclusion 251
8.9 Appendix 252
8.10 An Example of an Increase in the Default Probability Consecutive
to the Adoption of the Capital Requirement 258