Abstract
Existing studies suggest that systemic crises may arise because banks either hold correlated assets, or are connected by interbank lending. This paper shows that common regulation is also a conduit for interbank contagion. One banks failure may undermine confidence in the banking regulators competence, and, hence, in other banks chartered by the same regulator. As a result, depositors withdraw funds from otherwise unconnected banks. The optimal regulatory response to this behaviour can be privately to exhibit forbearance to a failing bank. We show that regulatory transparency improves confidence ex ante but impedes regulators ability to stem panics ex post.
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