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International Policy Coordination Mechanism with respect to the Moral Hazards of Financial Intermediaries

Economic Research Institute (82-2-759-5416) 2011.01.07 4176
Author : Young-Han Kim

This paper examines the impact of cross-border financial externalities on moral hazards of the banking sector, and an international policy coordination mechanism to reduce the moral hazards of the banking sector considering cross-border financial externalities. We demonstrate that the moral hazard of banking, such as reducing the monitoring efforts, is aggravated by cross-border financial externalities, while the introduction of an international policy coordination mechanism might reduce the moral hazard caused by these externalities.

Moreover, international policy coordination is less likely to be sustained when the policy maker is short-sighted and the banking sector has greater political influence. However, when the distortionary cost of a liquidity aids policy is lower with high administrative transparency, and cross-border financial externality is greater, the coordination mechanism is more likely to be sustained.

The results imply that efforts to launch an effective international financial coordination mechanism should start with countries with higher administrative transparency, more political stability, and enhanced financial integration .

1 . Introductio n 1

2 . The Model 7

2 .1 A benchmark case: welfare inefficiency of informational barriers in financial markets without

cross-border externalities 8

3 . Welfare inefficiency of informational barriers in financial markets with cross-border externalities 14

4 . International policy coordination to reduce the moral hazard of financial intermediaries under cross-border externalities 17

5 . Concluding remarks and implications 24


References 27