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Economic Quarterly

Winter 1998

Can a Safety Net Subsidy Be Contained?

John R. Walter

Banks may receive a subsidy from deposit insurance or from other components of the government-provided banking safety net. Extension (leakage) of a subsidy to banks' nonbank affiliates will only serve to enlarge it. But subsidy enlargement, since it entails expanded risks to taxpayers and reduced economic efficiency, seems to demand steps to prevent it. To contain bank-to-affiliate leaks, observers propose intracompany restrictions. While such restrictions may contain intracompany leaks, they cannot contain broader subsidy enlargement. Competition will compel banks to yield any subsidy to their borrowers and depositors, thereby frustrating public policy attempts to limit it.

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