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Walking Wounded or Living Dead? Making Banks Foreclose Bad Loans

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  • Max Bruche

    ()

  • Gerard Llobet

    ()

Abstract

Because of limited liability, insolvent banks have an incentive to roll over bad loans, in order to hide losses and gamble for resurrection, even though this is socially inefficient. We suggest a scheme that regulators could use to solve this problem. The scheme would induce banks to reveal their bad loans, which can then be foreclosed. Bank participation in the scheme would be voluntary. Even though banks have private information on the quantity of bad loans on their balance sheet, the scheme avoids creating windfall gains for bank equity holders. In addition, some losses can be imposed on debt holders.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/DP675_2011_WalkingWounded.pdf
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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp675.

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Date of creation: Mar 2011
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Handle: RePEc:fmg:fmgdps:dp675

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Web page: http://www.lse.ac.uk/fmg/

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