Banking and sovereign debt crises in a monetary union without central bank intervention |
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| Affiliation: | 1. Université d’Auvergne, CNRS-CERDI, France;2. Université de Strasbourg, CNRS-BETA, France;3. Aix-Marseille Université (Aix-Marseille School of Economics), CNRS-GREQAM & EHESS, France;4. Institut Universitaire de France, France;1. Bielefeld University, Center for Mathematical Economics, 33615 Bielefeld, Germany;2. University of Johannesburg, Faculty of Economics and Financial Sciences, South Africa;1. College of Economics and Management, Nanjing University of Aeronautics and Astronautics, Nanjing 211106, China;2. Department of Finance and Insurance, Lingnan University, 8 Castle Peak Road, Tuen Mun, Hong Kong;1. College of Economics and Management, Nanjing University of Aeronautics and Astronautics, Nanjing 211106, China;2. Department of Finance and Insurance, Lingnan University, Hong Kong;1. Institute for Financial and Actuarial Mathematics and Institute for Risk and Uncertainty, University of Liverpool, Center for Doctoral Training, Chadwick Building, G62, Liverpool, UK;2. Department of Economics, University of Pretoria, Kiel Institute for the World Economy, Private Bag X20, Hatfield 0028, South Africa |
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| Abstract: | We analyze the conditions of emergence of a twin banking and sovereign debt crisis within a monetary union in which: (i) the central bank is not allowed to provide direct financial support to stressed member states or to play the role of lender of last resort in sovereign bond markets, and (ii) the responsibility of fighting against large scale bank runs, ascribed to domestic governments, is ensured through the implementation of a financial safety net (banking regulation and government deposit guarantee). We show that this broad institutional architecture, typical of the Eurozone at the onset of the financial crisis, is not always able to prevent the occurrence of a twin banking and sovereign debt crisis triggered by pessimistic investors’ expectations. Without significant backstop by the central bank, the financial safety net may actually aggravate, instead of improve, the financial situation of banks and of the government. |
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| Keywords: | Banking crisis Sovereign debt crisis Bank runs Financial safety net Liquidity regulation Government deposit guarantee |
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