Resolving banking crises - an analysis of policy options
This paper develops a dynamic model to examine the ex-ante and ex-post implications of five policy options for resolving bank failures when the authorities cannot observe the level of non-performing loans (NPLs) held by individual banks. Under asymmetric information, we show that the first-best outcome is achievable when the authorities can close all banks that fail to raise a minimum level of new capital. But when the authorities cannot close banks and must rely on financial incentives to induce banks to liquidate their NPLs, recapitalisation using equity (Tier 1 capital) would be the second-best policy, whereas recapitalisation using subordinated debt (Tier 2 capital) is suboptimal. If the authorities do not wish to hold an equity stake in a bank, they should subsidise the liquidation of non-performing loans rather than inject subordinated debt. We also show that the cost of this subsidy can be reduced if it is offered in a menu that includes equity injection.
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- Philippe Aghion, Patrick Bolton & Steven Fries, 1999. "Optimal Design of Bank Bailouts: The Case of Transition Economies," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 155(1), pages 51-, March.
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William Davidson Institute Working Papers Series
290, William Davidson Institute at the University of Michigan.
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- Jenny Corbett & Janet Mitchell, 2000. "Banking crises and bank rescues: the effect of reputation," Proceedings, Federal Reserve Bank of Cleveland, pages 474-517.
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- Osano, Hiroshi, 2002. "Managerial compensation contract and bank bailout policy," Journal of Banking & Finance, Elsevier, vol. 26(1), pages 25-49, January.
- Glenn Hoggarth & Jack Reidhill & Peter Sinclair, 2004. "On the resolution of banking crises: theory and evidence," Bank of England working papers 229, Bank of England.
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- Marc Quintyn & David S. Hoelscher, 2003. "Managing Systemic Banking Crises," IMF Occasional Papers 224, International Monetary Fund.
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