When a bank calls in a loan, it obviously hurts the customer in question. But it also adversely affects other banks that have lent to this borrower. They are now less likely to be repaid and so can't as readily lend to their own customers.

A contingent bailout policy - implicit or explicit - must be coupled with some regulation of what banks can and cannot do. For example, a ban on lending to uncreditworthy customers might well make sense.

If banks anticipate government will come to the rescue should the credit market go badly awry, they may make loans that would otherwise be imprudent, e.g. subprime loans with little prospect of repayment.

Eric Maskin Quotes