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Bail-ins and Bail-outs: Incentives, Connectivity, and Systemic Stability

Author

Listed:
  • Benjamin Bernard
  • Agostino Capponi
  • Joseph E. Stiglitz

Abstract

This paper develops a framework to analyze the consequences of alternative designs for interbank networks, in which a failure of one bank may lead to others. Earlier work had suggested that, provided shocks were not too large (or too correlated), denser networks were preferred to more sparsely connected networks because they were better able to absorb shocks. With large shocks, especially when systems are non-conservative, the likelihood of costly bankruptcy cascades increases with dense networks. Governments, worried about the cost of bailouts, have proposed bail-ins, where banks contribute. We analyze the conditions under which governments can credibly implement a bail-in strategy, showing that this depends on the network structure as well. With bail-ins, government intervention becomes desirable even for relatively small shocks, but the critical shock size above which sparser networks perform better is decreased; with sparser networks, a bail-in strategy is more credible.

Suggested Citation

  • Benjamin Bernard & Agostino Capponi & Joseph E. Stiglitz, 2017. "Bail-ins and Bail-outs: Incentives, Connectivity, and Systemic Stability," NBER Working Papers 23747, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:23747
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    References listed on IDEAS

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    1. Antonio Cabrales & Piero Gottardi & Fernando Vega-Redondo, 2017. "Risk Sharing and Contagion in Networks," Review of Financial Studies, Society for Financial Studies, vol. 30(9), pages 3086-3127.
    2. Boissay, Frédéric, 2006. "Credit chains and the propagation of financial distress," Working Paper Series 573, European Central Bank.
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    Cited by:

    1. Zafer Kanık, 2017. "Rescuing the Financial System: Capabilities, Incentives, and Optimal Interbank Networks," Working Papers 17-17, NET Institute.
    2. Koetter, Michael & Krause, Thomas & Tonzer, Lena, 2017. "Delay determinants of European Banking Union implementation," IWH Discussion Papers 24/2017, Halle Institute for Economic Research (IWH).

    More about this item

    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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