Reestablishing Stability and Avoiding a Credit Crunch: Comparing Different Bad Bank Schemes
DICE Discussion Paper No. 31
39 Pages Posted: 8 Sep 2011
Date Written: August 8, 2011
Abstract
This paper develops a model to analyze two different bad bank schemes, an outright sale of toxic assets to a state-owned bad bank and a repurchase agreement between the bad bank and the initial bank. For both schemes, we derive a critical transfer payment that induces a bank manager to participate. Participation improves the bank's solvency and enables the bank to grant new loans. Therefore, both schemes can reestablish stability and avoid a credit crunch. However, an outright sale will be less costly to taxpayers than a repurchase agreement only if the transfer payment is sufficiently low.
Keywords: bad banks, financial crisis, financial stability, credit crunch
JEL Classification: G21, G28, G30
Suggested Citation: Suggested Citation