Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/228852 
Year of Publication: 
2020
Series/Report no.: 
ECONtribute Discussion Paper No. 049
Publisher: 
University of Bonn and University of Cologne, Reinhard Selten Institute (RSI), Bonn and Cologne
Abstract: 
We study the interaction between a government's bailout policy and banks' willingness to impose losses on (or \bail in") their investors. The government has limited commitment and may choose to bail out banks facing large losses. The anticipation of this bailout undermines a bank's private incentive to impose a bail-in. In the resulting equilibrium, bail-ins are too small and bailouts are too large. Some banks may also face a run by informed investors, creating further distortions and leading to larger bailouts. We show how a regulator with limited information can raise welfare and improve financial stability by imposing a system-wide, mandatory bail-in at the onset of a crisis. In some situations, allowing banks to choose between meeting a minimum bail-in and opting out can raise welfare further.
Subjects: 
Bank bailouts
moral hazard
financial stability
banking regulation
JEL: 
E61
G18
G28
Document Type: 
Working Paper

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