Bail-Ins and Bail-Outs: Incentives, Connectivity, and Systemic Stability
58 Pages Posted: 14 Apr 2017 Last revised: 16 Aug 2017
Date Written: August 15, 2017
This paper develops a framework to analyze welfare losses in an interbank network, in which subsidized bail-ins or public bailouts can be coordinated to stop financial contagion. Banks are willing to contribute to a bail-in only if the social planner's threat to not bail out insolvent banks is credible. The possibility of strategic intervention reverses the presumptions in earlier works and promotes sparsely connected networks over densely connected ones because (i) the no-intervention threat exhibits a phase transition and becomes more credible for large shocks and (ii) banks' contributions to the coordinated bail-in plan are larger.
Keywords: Systemic Risk, Bail-Ins, Bail-Outs, Connectivity, Financial Stability
JEL Classification: G01, D85, L14
Suggested Citation: Suggested Citation