Credit Insurance, Bailout and Systemic Risk

Download or read book Credit Insurance, Bailout and Systemic Risk written by Kaushalendra Kishore and published by . This book was released on 2018 with total page 35 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper studies the impact of expectation of bailout of a credit insurance firm on the investment strategies of the counterparty banks. If the failure of credit insurance firm may result in the bankruptcy of its counterparty banks, then the regulator will be forced to bail it out. This imperfectly targeted time inconsistent policy incentivizes the banks to make correlated investments ex ante. All banks want their assets to fail exactly at the time when the bailout is occurring to indirectly benefit from the bailout of the insurance firm and hence they make correlated investments. I build a model in which correlated investment by banks, under priced insurance contracts and a systemically important insurance firm arise endogenously and show that while credit insurance helps in risk sharing during good times, it can also create systemic risk. I also show that putting a limit on size of insurance firm can mitigate this problem.