A Soft Bail-Out Concept to Reduce Contagion in Financial Systems

44 Pages Posted: 25 Jan 2012

See all articles by Wolfgang Aussenegg

Wolfgang Aussenegg

Vienna University of Technology

Bernhard Kronfellner

Vienna University of Technology - Department of Finance and Corporate Control

Date Written: January 23, 2012

Abstract

Problem: The financial crisis of 2007-2009 has shown that regional problems in the financial industry can quickly spread over to the complete financial system and can even affect the worldwide economy. Thus, current financial systems are characterized by a high degree of interconnections and consequently a high amount of system risk. Objective: To reduce systemic risks, regulators and governments have to understand their main drivers. Upon this understanding, they need concepts of how to use most efficiently funds of new bank taxes. Method: By modeling the financial system with its interactions as stochastic processes we are able to simulate the two main reasons for systemic risks – macroeconomic shocks and contagion – at the same time. Results: Based on our model of the financial system we propose the new concept of 'soft-bail-outs.' Compared to the current best practice of bank bail-outs, soft-bail-outs tend to reduce the probability of default of the whole financial system, lower the bail-out costs, and decrease the bail-out cost volatility. Application: This new concept of soft-bail-outs and the understanding of sensitivities to systemic risk can help regulators and governments to strengthen the financial system with fewer costs. In particular, we derive three suggestions to regulators of how to adapt the current regulatory regime.

Keywords: Systemic Risk, Contagion, Bail-Out, Bank Tax, Financial Crisis, Bank Fragility, Bank Failure, Financial Stability

JEL Classification: G01, G21, G28, G33

Suggested Citation

Aussenegg, Wolfgang and Kronfellner, Bernhard, A Soft Bail-Out Concept to Reduce Contagion in Financial Systems (January 23, 2012). Available at SSRN: https://ssrn.com/abstract=1990513 or http://dx.doi.org/10.2139/ssrn.1990513

Wolfgang Aussenegg (Contact Author)

Vienna University of Technology ( email )

Theresianumgasse 27
Vienna, A-1040
Austria
+43 1 58801 33082 (Phone)
+43 1 58801 33098 (Fax)

HOME PAGE: http://www.imw.tuwien.ac.at/fc/people/wolfgang_aussenegg/

Bernhard Kronfellner

Vienna University of Technology - Department of Finance and Corporate Control ( email )

Favoritenstrasse 9-11
A-1040 Vienna
Austria
+436765797379 (Phone)

HOME PAGE: http://www.kronfellner.at.tf

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