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Bank Bail-Outs, International Linkages and Cooperation

  • Friederike Niepmann
  • Tim Schmidt-Eisenlohr

Financial institutions are increasingly linked internationally and engaged in cross-border operations. As a result, financial crises and potential bail-outs by governments have important international implications. Extending Allen and Gale (2000) we provide a model of international contagion allowing for bank bail-outs financed by distortionary taxes. In the sequential game between governments, there are inefficiencies due to spillovers, free-riding and limited burden-sharing. When countries are of equal size, an increase in cross-border deposit holdings improves, in general, the non-cooperative outcome. For efficient crisis managment, ex-ante fiscal burden sharing is essential as ex-post contracts between governments do not achieve the same global welfare.

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Paper provided by European University Institute in its series Economics Working Papers with number ECO2010/05.

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Date of creation: 2010
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Handle: RePEc:eui:euiwps:eco2010/05
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