Public Guarantees on Bank Bonds: Effectiveness and Distortions

Abstract

The government guarantees on bank bonds adopted in 2008 in many advanced economies to support the banking systems were broadly effective in resuming bank funding and preventing a credit crunch. The guarantees, however, also caused distortions in the cost of bank borrowing. Their reintroduction might help alleviate the current pressures on banks caused by the sovereign debt crisis, but the pricing mechanism should ensure a level playing field. Moreover, given the sharp deterioration in the creditworthiness of sovereign borrowers, it may be envisaged to entrust the provision of the guarantees to a supranational organisation.