Financial safety net design and systemic stability

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Recent decades have seen a significant rise in systemic banking sector issues. This study explores the role of financial safety net design in financial distress episodes and efforts to prevent them. Two main policy perspectives have emerged in response to increased fragility. One perspective views explicit safety net guarantees as a contributing factor to fragility, advocating for their removal as a reform starting point. The other perspective attributes excessive risk-taking by banks to the fundamental commitment problem faced by governments, which leads to conflicting goals for politicians, regulators, and supervisors, making them hesitant to impose certain measures on bank stakeholders. Addressing this challenge requires intelligent mechanism design that focuses on appropriate institutional arrangements aligned with safety net players' incentives, rather than simply abolishing safety nets. The study aims to enhance empirical literature by assessing the relative significance of these arguments and to deepen understanding of the incentive issues faced by safety net players and the mechanisms that could mitigate them. This involves a comprehensive examination of institutional details and their evolution over recent decades. The financial safety net is characterized as a dynamic set of functions, institutions, and organizations. The study employs historical insights, case studies, and econometric techniques to provide new persp