Expanded government guarantees for bank liabilities: Selected issues

Government provision of a safety net for financial institutions has been a key element of the policy response to the current crisis. In the process, existing guarantees have been expanded and new ones introduced, including, in particular, in relation to bank liabilities. Among other things, such guarantees create costs that arise as a result of potential distortions of incentives and competition. To limit such distortions it is important to specify risk-based premiums for additional government-provided guarantees, and to the extent that guarantees are priced appropriately potential distortions also should be limited. The evidence however has been mixed in this regard. The present article discusses pricing and some other selected issues related to the recent expansion of guarantees for bank liabilities.