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Optimal Design of Bank Bailouts: Prompt Corrective Action

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  • J-P. Niinimaki

Abstract

The paper investigates the optimal design of bank bailouts. Under three types of ex post moral hazard that tempt banks to hide loan losses, the paper analyzes banking regulation via three Prompt Corrective Action instruments: prohibition of dividends, limits on compensation to managers and early closure policy. The first two have a mitigating effort on moral hazard but the last instrument has a damaging impact. As to bad debts and the cleaning of banks' balance sheets, asset insurance and equity capital motivate banks to disclose loan losses. In some cases, prohibition of dividends or limits on compensation to managers has the same effect.

Suggested Citation

  • J-P. Niinimaki, 2011. "Optimal Design of Bank Bailouts: Prompt Corrective Action," Discussion Papers 69, Aboa Centre for Economics.
    • Handle: RePEc:tkk:dpaper:dp69
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    More about this item

    Keywords

    Financial intermediation; Mechanism design; Bank bailouts; Banking regulation; Prompt Corrective Action;
    All these keywords.

    JEL classification:

    • 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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