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Bank Bailout Menus

Author

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  • Sudipto BHATTACHARYA

    (London School of Economics and CEPR)

  • Kjell G. NYBORG

    (University of Zurich, Swiss Finance Institute, NHH and CEPR)

Abstract

Bailing out banks requires overcoming debt overhang as well as dealing with adverse selection with respect to the quality of banks' balance sheets, in terms of heterogeneity in both the likelihood and extent of their potential shortfalls, of future asset values vis-a-vis contractual debt obligations. We examine bailouts that eliminate debt overhang, while attempting to minimize subsidies to banks' equityholders. When banks do not differ with respect to the extent of debt overhang, it can be fully overcome with the minimal amount of subsidies, providing each bank's equity holders no more than their pre-bailout values, with a partial new equity injection, or an asset buyout. When levels of debt overhang co- vary with underlying probabilities of default, we characterize the conditions for attaining a similar minimal subsidy outcome, with a Menu of either equity injection or asset buyout plans, satisfying suitable self-selection constraints among bank types. These involve global rather than local conditions, with multiple intersections of indifference curves among types, and imply strictly greater funds injections than those needed to make existing debt default- free. We also explore the role of coupling asset purchases with providing the bailout agency Options to buy bank equity, to enhance its capture of rents arising from new investments by banks. We compare its performance with equity injections on this dimension, as well as others such as post-bailout stakes held by prior inside equity holders of banks.

Suggested Citation

  • Sudipto BHATTACHARYA & Kjell G. NYBORG, 2010. "Bank Bailout Menus," Swiss Finance Institute Research Paper Series 10-24, Swiss Finance Institute.
  • Handle: RePEc:chf:rpseri:rp1024
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    References listed on IDEAS

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    Cited by:

    1. Martynova, Natalya & Perotti, Enrico C. & Suárez, Javier, 2020. "Bank capital forbearance and serial gambling," Discussion Papers 56/2020, Deutsche Bundesbank.
    2. King, Michael R., 2019. "Time to buy or just buying time? Lessons from October 2008 for the cross-border bailout of banks," Journal of Financial Stability, Elsevier, vol. 41(C), pages 55-72.
    3. Viral Acharya & Itamar Drechsler & Philipp Schnabl, 2014. "A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk," Journal of Finance, American Finance Association, vol. 69(6), pages 2689-2739, December.
    4. Eijffinger, Sylvester & Nijskens, Rob, 2011. "Complementing Bagehot: Illiquidity and insolvency resolution," CEPR Discussion Papers 8603, C.E.P.R. Discussion Papers.
    5. Brei, Michael & Gambacorta, Leonardo & von Peter, Goetz, 2013. "Rescue packages and bank lending," Journal of Banking & Finance, Elsevier, vol. 37(2), pages 490-505.
    6. Bachmann, Manuel, 2018. "The Impact of Ex Ante Regulations and Ex Post Interventions on Bank Lending and Solvency," Department of Economics Working Paper Series 269, WU Vienna University of Economics and Business.
    7. Beccalli, Elena & Frantz, Pascal & Lenoci, Francesca, 2018. "Hidden effects of bank recapitalizations," Journal of Banking & Finance, Elsevier, vol. 94(C), pages 297-314.
    8. 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.
    9. Anat R. Admati & Peter M. Demarzo & Martin F. Hellwig & Paul Pfleiderer, 2018. "The Leverage Ratchet Effect," Journal of Finance, American Finance Association, vol. 73(1), pages 145-198, February.
    10. Occhino, Filippo, 2017. "Debt-overhang banking crises: Detecting and preventing systemic risk," Journal of Financial Stability, Elsevier, vol. 30(C), pages 192-208.
    11. Hryckiewicz, Aneta, 2014. "The problem with government interventions: The wrong banks, inadequate strategies, or ineffective measures?," MPRA Paper 64074, University Library of Munich, Germany.
    12. Occhino, Filippo & Pescatori, Andrea, 2015. "Debt overhang in a business cycle model," European Economic Review, Elsevier, vol. 73(C), pages 58-84.
    13. Beccalli, Elena & Frantz, Pascal & Lenoci, Francesca, 2018. "Hidden effects of bank recapitalizations," LSE Research Online Documents on Economics 89252, London School of Economics and Political Science, LSE Library.
    14. Haavio, Markus & Ripatti, Antti & Takalo, Tuomas, 2016. "Saving Wall Street or main street," Research Discussion Papers 12/2016, Bank of Finland.
    15. Willem Vanlaer & Mattia Picarelli & Wim Marneffe, 2021. "Debt and Private Investment: Does the EU Suffer from a Debt Overhang?," Open Economies Review, Springer, vol. 32(4), pages 789-820, September.
    16. Hauck, Achim & Vollmer, Uwe, 2013. "Emergency liquidity provision to public banks: Rules versus discretion," European Journal of Political Economy, Elsevier, vol. 32(C), pages 193-204.
    17. Philippon, Thomas & Schnabl, Philipp, 2011. "Informational Rents, Macroeconomic Rents, and Efficient Bailouts," CEPR Discussion Papers 8216, C.E.P.R. Discussion Papers.
    18. Occhino, Filippo, 2017. "The 2012 eurozone crisis and the ECB’s OMT program: A debt-overhang banking and sovereign crisis interpretation," European Economic Review, Elsevier, vol. 100(C), pages 337-363.
    19. Manuel Bachmann, 2018. "The Impact of Ex Ante Regulations and Ex Post Interventions on Bank Lending and Solvency," Department of Economics Working Papers wuwp269, Vienna University of Economics and Business, Department of Economics.
    20. Chang, Chuen-Ping, 2014. "A barrier option framework for rescue package designs and bank default risks," Economic Modelling, Elsevier, vol. 38(C), pages 246-257.
    21. Filippo Occhino, 2014. "Debt-Overhang Banking Crises," Working Papers (Old Series) 1425, Federal Reserve Bank of Cleveland.
    22. repec:zbw:bofrdp:2016_012 is not listed on IDEAS

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    More about this item

    Keywords

    Bailouts; Subsidies; Debt overhang; Private information; Self-selection;
    All these keywords.

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G01 - Financial Economics - - General - - - Financial Crises
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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