Risk Absorption by the State : When Is It Good Public Policy?

The global financial crisis brought public guarantees to the forefront of the policy debate. Based on a review of the theoretical foundations of public guarantees, this paper concludes that the commonly used justifications for public guarantees bas...

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Bibliographic Details
Main Authors:	Anginer, Deniz, de la Torre, Augusto, Ize, Alain
Format:	Policy Research Working Paper
Language:	English
Published:	2012
Subjects:	ABOVE MARKET RATES ACCESS TO FINANCE AGENCY PROBLEMS AGENTS ALLOCATION OF CREDIT ANNUITIES ARBITRAGE ASSET MANAGERS ASYMMETRIC INFORMATION AUCTION BAILOUT BALANCE SHEETS BANK POLICY BANK RUN BIASES BID BOND BOND ISSUERS BONDS BORROWING BORROWING CAPACITY BUSINESS DEVELOPMENT BUSINESS DEVELOPMENT BANK CAPITAL ACCUMULATION CAPITAL INJECTIONS CC CENTRAL BANKS CHECKS COLLATERAL REQUIREMENTS COLLECTIVE ACTION COLLECTIVE ACTION PROBLEM COLLECTIVE ACTION PROBLEMS COLLEGE EDUCATION COMMERCIAL BANK COMMERCIAL BANKS CONFLICTS OF INTEREST CONSUMER CREDIT CONTAINING SYSTEMIC RISK CONTRACT ENFORCEMENT COORDINATION FAILURES CORPORATE FINANCE COST OF CAPITAL COST OF LOAN COST SHARING COVERAGE CREDIT DEFAULT CREDIT EXPANSION CREDIT GUARANTEE CREDIT GUARANTEES CREDIT MARKET CREDIT MARKETS CREDIT POLICY CREDIT PROGRAMS CREDIT RATIONING CREDITORS DEBT DEFAULT LOSSES DEGREE OF RISK DEPOSIT DEPOSIT GUARANTEES DEPOSIT INSURANCE DEVELOPMENT BANK DEVELOPMENT BANKS DIFFERENTIAL TAXATION DIRECTED CREDIT DISCLOSURE REQUIREMENTS EARNINGS ECONOMIES OF SCALE EMPLOYEE ENABLING ENVIRONMENT ENTREPRENEUR ENTREPRENEURS EXTERNALITIES FAIR PRICE FEDERAL RESERVE FEDERAL RESERVE BANK FINANCIAL CRISES FINANCIAL CRISIS FINANCIAL DEVELOPMENT FINANCIAL FRAGILITY FINANCIAL INTERMEDIARIES FINANCIAL INTERMEDIATION FINANCIAL MARKETS FINANCIAL RISK FINANCIAL SERVICES FINANCIAL SERVICES INDUSTRY FINANCIAL STABILITY FINANCIAL SYSTEM FINANCIAL SYSTEMS FISCAL CONSTRAINTS FORM OF CREDIT GOVERNMENT GUARANTEES GOVERNMENT INTERVENTION GRANT PROGRAMS GUARANTEE FUNDS GUARANTEE SCHEME GUARANTEE SCHEMES GUARANTOR GUARANTORS HEALTH INSURANCE HEDGE FUNDS HOLDINGS HOUSEHOLDS HOUSING IMPERFECT INFORMATION INCOME DISTRIBUTION INEQUALITIES INFORMATION ASYMMETRIES INFORMATION ASYMMETRY INFRASTRUCTURE FINANCE INSURANCE INSURANCE MARKETS INSURANCE PREMIUM INTEREST PAYMENTS INTEREST RATE INTEREST RATES INTERNATIONAL BANK INTERNATIONAL FINANCE INVESTMENT DECISIONS INVESTMENT PROJECTS JOINT STOCK COMPANIES JOINT STOCK COMPANY LACK OF COLLATERAL LENDER LENDER OF LAST RESORT LENDER-OF-LAST-RESORT LENDERS LIABILITY LIQUIDATION LIQUIDATION VALUE LIQUIDATIONS LIQUIDITY LIQUIDITY RISK LOAN APPLICANTS LOAN DEFAULT LOAN GUARANTEE LOAN GUARANTEE PROGRAM LOAN GUARANTEE PROGRAMS LOAN LOSS PROVISIONS LOAN MARKET LOAN MARKETS LOAN PROGRAMS LOAN REPAYMENT LONG-TERM FINANCE LONG-TERM INSTRUMENTS LONG-TERM LOANS LOW INTEREST RATES MACROECONOMIC POLICY MANDATES MARKET DEPTH MARKET FAILURE MARKET FAILURES MARKET INEFFICIENCY MARKET LIQUIDITY MARKET PARTICIPANTS MATURITY MDB MORAL HAZARD MORTGAGE MORTGAGE FINANCE MULTILATERAL DEVELOPMENT BANKS MUTUAL FUNDS PARTIAL CREDIT PARTIAL GUARANTEE PARTIAL GUARANTEES PARTICIPATION CONSTRAINTS PEER PRESSURE PENSION PENSION FUNDS POLICY RESPONSE POLICY RESPONSES POLITICAL ECONOMY PRICE RISK PRICE VOLATILITY PRIVATE BANKS PRIVATE INVESTMENT PRIVATE LENDER PRIVATE LENDERS PRIVATIZATION PROBABILITY OF REPAYMENT PROFITABILITY PUBLIC BANKS PUBLIC INVESTMENT PUBLIC LENDERS PUBLIC POLICY RATE OF RETURN RATING AGENCIES REAL ESTATE REINSURANCE REPAYMENT REPAYMENTS RESERVES RETAIL INVESTORS RETURNS RISK AVERSION RISK FRONTIER RISK MANAGEMENT RISK NEUTRAL RISK PREMIUM RISK TAKING RISK TRANSFER RULE OF LAW SETTLEMENT SHAREHOLDERS SMALL BUSINESS SMALL BUSINESS LOAN SMALL FARMERS SOCIAL WELFARE STATE BANK STATE BANKING STATE BANKS STATE GUARANTEE STATE GUARANTEES STATE INTERVENTION STATE LOAN STUDENT LOAN STUDENT LOANS SUBSIDIZATION SWAP SYSTEMIC RISK TAX TAX SYSTEM TRADING TRANSFER PAYMENT TRANSPARENCY UNDERWRITING UNEMPLOYMENT WAGES WHOLESALE FUNDING
Online Access:	http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20111202104813 http://hdl.handle.net/10986/3660

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Summary:	The global financial crisis brought public guarantees to the forefront of the policy debate. Based on a review of the theoretical foundations of public guarantees, this paper concludes that the commonly used justifications for public guarantees based solely on agency frictions (such as adverse selection or lack of collateral) and/or un-internalized externalities are flawed. When risk is idiosyncratic, it is highly unlikely that a case for guarantees can be made without risk aversion. When risk aversion is explicitly added to the picture, public guarantees may be justified by the state's natural advantage in dealing with collective action failures (providing public goods). The state can spread risk more finely across space and time because it can coordinate and pool atomistic agents that would otherwise not organize themselves to solve monitoring or commitment problems. Public guarantees may be transitory, until financial systems mature, or permanent, when risk is fat-tailed. In the case of aggregate (non-diversifiable) risk, permanent public guarantees may also be justified, but in this case the state adds value not by spreading risk but by coordinating agents. In addition to greater transparency in justifying public guarantees, the analysis calls for exploiting the natural complementarities between the state and the markets in bearing risk.

Risk Absorption by the State : When Is It Good Public Policy?

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