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Inside money, procyclical leverage, and banking catastrophes.

ABSTRACT: We explore a model of the interaction between banks and outside investors in which the ability of banks to issue inside money (short-term liabilities believed to be convertible into currency at par) can generate a collapse in asset prices and widespread bank insolvency. The banks and investors share a common belief about the future value of certain long-term assets, but they have different objective functions; changes to this common belief result in portfolio adjustments and trade. Positive belief shocks induce banks to buy risky assets from investors, and the banks finance those purchases by issuing new short-term liabilities. Negative belief shocks induce banks to sell assets in order to reduce their chance of insolvency to a tolerably low level, and they supply more assets at lower prices, which can result in multiple market-clearing prices. A sufficiently severe negative shock causes the set of equilibrium prices to contract (in a manner given by a cusp catastrophe), causing prices to plummet discontinuously and banks to become insolvent. Successive positive and negative shocks of equal magnitude do not cancel; rather, a banking catastrophe can occur even if beliefs simply return to their initial state. Capital requirements can prevent crises by curtailing the expansion of balance sheets when beliefs become more optimistic, but they can also force larger price declines. Emergency asset price supports can be understood as attempts by a central bank to coordinate expectations on an equilibrium with solvency.

SUBMITTER: Brummitt CD

PROVIDER: S-EPMC4138099 | biostudies-literature |

REPOSITORIES: biostudies-literature

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Project description:Background: We examined recent trends in mobile money and branchless banking regulations related to cash-in, cash-out (CICO) networks (physical access points allowing users to exchange physical cash and electronic money) in low- and middle-income countries, and reviewed evidence on the impacts of CICO regulations on markets and financial inclusion. Methods: Regulation and literature searches began in August 2017 and concluded in June 2018. For the regulatory search we compiled an original database of regulations targeting CICO networks in Bangladesh, India, Indonesia, Kenya, Nigeria, Pakistan, Tanzania, and Uganda. To review evidence of impacts of regulations we conducted additional global searches on Scopus, Google Scholar, and Google using keywords for specific regulatory approaches (e.g., regulation of CICO agents) or hypothesized impacts (e.g., financial inclusion). Results: The resulting database of CICO regulations in the eight focus countries includes 127 regulatory documents, which we coded for four groups of regulations, namely: Business Channel Requirements; Agent Requirements; Regulations on Caps, Fees and Charges; and Customer Identification Requirements. Early CICO regulations focused on agent selection rules, limits on fees, and know-your-customer requirements. More recent waves of regulation have expanded or restricted services CICO agents provide, and also imposed reporting requirements on service providers in an effort to prevent fraud or enhance financial inclusion. Our search for evidence of impacts of CICO regulations resulted in a sample of 90 documents published since 2005, of which only 31 provided evidence on CICO regulation impacts, with most limited in scope-suggesting rigorous policy analysis remains lacking in this quickly expanding sector. Conclusions: Many low- and middle-income countries have introduced regulations that may affect CICO networks, with regulatory approaches differing across geographies and over time. While anecdotal reports of regulatory impacts exist, we found limited evidence of impacts of regulations on CICO networks or on CICO-related financial inclusion.

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Inside money, procyclical leverage, and banking catastrophes.

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