The Subsidy Provided by the Federal Safety Net: Theory and Evidence

  • Myron L. Kwast
  • S. Wayne Passmore
Chapter

Abstract

Views about the value to depository institutions of the federal safety net differ widely. Resolution of the issue is important because defining the appropriate relationship between the federal safety net and financial institutions is central to the design of efficient financial modernization strategies. A heuristic model is presented of how the safety net subsidy affects the size of the banking system and the behavior of banks. The model suggests that banks should have lower capital ratios than similar nonbank financial firms. Evidence is presented that supports this prediction and that banks have organized themselves in ways that take advantage of safety net benefits.

Key words

banking subsidy safety net 
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Copyright information

© Springer Science+Business Media New York 2000

Authors and Affiliations

  • Myron L. Kwast
    • 1
  • S. Wayne Passmore
    • 1
  1. 1.Board of Governors of the Federal Reserve SystemUSA

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