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Bail-in vs. Bailout: a False Dilemma?

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Abstract

This paper analyzes the effects of bail-in policies on banks’ funding cost, incentives for loan monitoring, and financing capacity. In a model with moral hazard and two investment stages, a full bail-in turns out to be, ex post, the first-best policy to deal with failing banks. As a consequence, however, investors expect bail-ins rather than bailouts. Ex ante, this raises banks’ cost of debt and depresses bankers’ incentives to monitor. When moral hazard is severe, this time inconsistency leads to a credit market collapse unless the government pre-commits to an alternative resolution policy. The optimal policy is either a combination of bail-in and bailout or liquidation, depending on the severity of moral hazard and the shadow cost of the partial bailout.

Suggested Citation

  • Lorenzo Pandolfi, 2018. "Bail-in vs. Bailout: a False Dilemma?," CSEF Working Papers 499, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  • Handle: RePEc:sef:csefwp:499
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    More about this item

    Keywords

    bail-in; bailout; moral hazard; resolution policies; bank regulation.;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • 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

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