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Debt overhang and bank bailouts


  • Linus Wilson


When a bank is deemed 'too big to fail' by regulators, it may be tempted to buy risky assets. This paper analyses bank bailouts involving the purchases of toxic assets, preferred stock and common stock when the government wants to encourage efficient lending. It finds that preferred stock recapitalisations are the least efficient in correcting debt overhang problems from both an ex post and ex ante perspective. In contrast, efficient lending and voluntary participation can be best achieved without subsidy by purchasing either toxic assets or common stock. Nevertheless, troubled banks must be subsidised if they will voluntarily participate in any recapitalisation.

Suggested Citation

  • Linus Wilson, 2012. "Debt overhang and bank bailouts," International Journal of Monetary Economics and Finance, Inderscience Enterprises Ltd, vol. 5(4), pages 395-414.
  • Handle: RePEc:ids:ijmefi:v:5:y:2012:i:4:p:395-414

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    References listed on IDEAS

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    Cited by:

    1. Bulow, Jeremy & Klemperer, Paul, 2013. "Market-Based Bank Capital Regulation," Research Papers 2132, Stanford University, Graduate School of Business.
    2. Iwanicz-Drozdowska, Małgorzata & Smaga, Paweł & Witkowski, Bartosz, 2016. "Bank restructuring in the EU: Which way to go?," Journal of Policy Modeling, Elsevier, vol. 38(3), pages 572-586.
    3. Khan, Mozaffar & Vyas, Dushyantkumar, 2015. "The Capital Purchase Program and subsequent bank SEOs," Journal of Financial Stability, Elsevier, vol. 18(C), pages 91-105.
    4. Ning Gong & Kenneth D. Jones, 2013. "Bailouts, Monitoring, and Penalties: An Integrated Framework of Government Policies to Manage the Too-Big-to-Fail Problem," International Review of Finance, International Review of Finance Ltd., vol. 13(3), pages 299-325, September.
    5. Hauck, Achim & Neyer, Ulrike & Vieten, Thomas, 2015. "Reestablishing stability and avoiding a credit crunch: Comparing different bad bank schemes," The Quarterly Review of Economics and Finance, Elsevier, vol. 57(C), pages 116-128.
    6. repec:eee:eecrev:v:100:y:2017:i:c:p:337-363 is not listed on IDEAS
    7. Occhino, Filippo, 2014. "Debt-Overhang Banking Crises," Working Paper 1425, Federal Reserve Bank of Cleveland.
    8. repec:eee:finsta:v:30:y:2017:i:c:p:192-208 is not listed on IDEAS


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