The Dialectical Role of Information and Disinformation in Regulation-induced Banking Crises

The severity of banking crises increases with disinformation about the losses banks incur in making politically directed loans and about the budgetary costs to the government of standing ready to absorb these losses increases. When (as it eventually must) such disinformation begins to lose credibility, silent runs test the government’s commitment to supporting its insolvent banks. An open banking crisis does not emerge until the size of unbooked obligations has become large enough to overwhelm the government’s implicit and explicit support system. Multilateral assistance offered countries that experience banking crises should transmit incentives for prompt insolvency resolution, for reliable information disclosure, and for developing plans for dealing with future financial disasters. JEL Classification Codes: F34, G18, G21