Abstract
A contingent liability is a commitment to take on an actual liability that could be realized in the future. International organizations emphasize the dangers of contingent liabilities when providing advice. Why? One reason is that when contingent liabilities are realized they often commit governments to substantial fiscal costs. Another reason is subtler: by taking on a contingent liability the government can increase the probability of the event that would trigger its realization. This paper focuses on a particular case: it describes the process by which government guarantees to bank creditors can make a banking system more fragile.
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This paper was presented at the 7th Dubrovnik Economics Conference organized by the Croatian National Bank in June 2001. Other papers from the conference will be included in the June 2002 issue of this journal which will be devoted to the conference proceedings.