Bail-in vs. Bailout: A Persuasion Game

Post-2008-09 resolution plans have substituted bailout for bail-in to protect taxpayers' money. However, in practice, bail-in and bailout are complementary because current resolution plans are not always executed as they should be and governments still have the possibility to intervene to maintain financial stability. We contribute to this discussion on resolution mechanisms with a focus on information design by introducing a theoretical resolution scheme to highlight the complementary nature of bail-ins and bailouts. In our framework, the role of the resolution authority is to select the optimal disclosure rule that reduces its ex-ante expected loss function to ensure financial stability. To do so, the resolution authority discloses information about the asset quality of the distressed bank and the probability of bailout by the government, and the healthy bank can either accept or refuse the bail-in proposal. We show that when the option to bail out the distressed bank exists, the healthy bank may refuse to save the distressed bank that it could otherwise have saved if the government could not bail it out. We find, as a policy implication, that full disclosure is desirable in some circumstances, especially in extreme states of the economy, but not in others. For instance, in a crisis period and when the bail-in cost is large, the optimal loss is reached thanks to full disclosure.