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Bank capital, interbank contagion, and bailout policy

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  • Tian, Suhua
  • Yang, Yunhong
  • Zhang, Gaiyan

Abstract

This paper develops a theoretical framework in which asset linkages in a syndicated loan agreement can infect a healthy bank when its partner bank fails. We investigate how capital constraints affect the choice of the healthy bank to takeover or liquidate the exposure held jointly with the failing bank, and how the bank’s ex ante optimal capital holding and possibility of contagion are affected by anticipation of bail-out policy, capital requirements and the joint exposure. We identify a range of factors that strengthen or weaken the possibility of contagion and bailout. Recapitalization with common stock rather than preferred equity injection dilutes existing shareholder interests and gives the bank a greater incentive to hold capital to cope with potential contagion. Increasing the minimum regulatory capital does not necessarily reduce contagion, while the requirement of holding conservation capital buffer could increase the bank’s resilience to avoid contagion.

Suggested Citation

  • Tian, Suhua & Yang, Yunhong & Zhang, Gaiyan, 2013. "Bank capital, interbank contagion, and bailout policy," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2765-2778.
  • Handle: RePEc:eee:jbfina:v:37:y:2013:i:8:p:2765-2778
    DOI: 10.1016/j.jbankfin.2013.03.024
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    Cited by:

    1. Iftekhar Hasan & Liuling Liu & Gaiyan Zhang, 2016. "The Determinants of Global Bank Credit-Default-Swap Spreads," Journal of Financial Services Research, Springer;Western Finance Association, vol. 50(3), pages 275-309, December.
    2. Jan Bruha & Evžen Kocenda, 2017. "Financial Stability in Europe: Banking and Sovereign Risk," CESifo Working Paper Series 6453, CESifo Group Munich.
    3. Jean-Charles Rochet & Guillaume Roger, 2016. "Risky utilities," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 62(1), pages 361-382, June.
    4. repec:eee:intfin:v:48:y:2017:i:c:p:135-145 is not listed on IDEAS
    5. repec:eee:finlet:v:22:y:2017:i:c:p:140-145 is not listed on IDEAS
    6. repec:ura:ecregj:v:1:y:2018:i:1:p:303-314 is not listed on IDEAS

    More about this item

    Keywords

    Interbank linkages; Optimal capital holding; Contagion; Bailout policy; Regulatory capital requirement; Takeover; Liquidation;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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