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.
|Date of creation:||Mar 2006|
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- Jenny Corbett & Janet Mitchell, 2000.
"Banking Crises and Bank Rescues: The Effect of Reputation,"
William Davidson Institute Working Papers Series
290, William Davidson Institute at the University of Michigan.
- Jenny Corbett & Janet Mitchell, 2000. "Banking crises and bank rescues: the effect of reputation," Proceedings, Federal Reserve Bank of Cleveland, pages 474-517.
- Corbett, Jenny & Mitchell, Janet, 2000. "Banking Crises and Bank Rescues: The Effect of Reputation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 474-512, August.
- 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.
- Osano, Hiroshi, 2002. "Managerial compensation contract and bank bailout policy," Journal of Banking & Finance, Elsevier, vol. 26(1), pages 25-49, January.
- Mitchell, Janet, 2001. "Bad Debts and the Cleaning of Banks' Balance Sheets: An Application to Transition Economies," Journal of Financial Intermediation, Elsevier, vol. 10(1), pages 1-27, January.
- Calomiris, Charles W., 1999. "Building an incentive-compatible safety net," Journal of Banking & Finance, Elsevier, vol. 23(10), pages 1499-1519, October.
- Leslie E Teo & Charles Enoch & Carl-Johan Lindgren & TomÃ¡s J. T. BaliÃ±o & Anne Marie Gulde & Marc G Quintyn, 2000. "Financial Sector Crisis and Restructuring; Lessons from Asia: Lessons from Asia," IMF Occasional Papers 188, International Monetary Fund.
- Marc G Quintyn & David S. Hoelscher, 2003. "Managing Systemic Banking Crises," IMF Occasional Papers 224, International Monetary Fund.
- 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 1-51, March.
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