Bail-Ins and Bail-Outs: Incentives, Connectivity, and Systemic Stability

47 Pages Posted: 14 Apr 2017 Last revised: 21 Sep 2018

See all articles by Benjamin Bernard

Benjamin Bernard

University of California, Los Angeles (UCLA) - Department of Economics

Agostino Capponi

Columbia University

Joseph E. Stiglitz

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

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Date Written: September 20, 2018

Abstract

We develop a framework for analyzing how banks can be incentivized to make contributions to a voluntary bail-in and ascertaining the kinds of interbank linkages that are most conducive to a bail-in. A bail-in is possible only when the regulator's threat to not bail out insolvent banks is credible. Incentives to join a rescue consortium are stronger in networks where banks have a high exposure to default contagion, and weaker if banks realize that a large fraction of the bene ts resulting from their contributions accrue to others. Our results reverse existing presumptions about the relative merits of different network topologies for moderately large shock sizes: while diversi fication effects reduce welfare losses in models without intervention, they inhibit the formation of bail-ins by introducing incentives for free-riding. We provide a nuanced understanding of why certain network structures are preferable, identifying the impact of the network structure on the credibility of bail-in proposals.

Keywords: Systemic Risk, Bail-Ins, Bail-Outs, Credibility, Financial Stability

JEL Classification: G01, D85, L14

Suggested Citation

Bernard, Benjamin and Capponi, Agostino and Stiglitz, Joseph E., Bail-Ins and Bail-Outs: Incentives, Connectivity, and Systemic Stability (September 20, 2018). Columbia Business School Research Paper No. 17-45. Available at SSRN: https://ssrn.com/abstract=2951448 or http://dx.doi.org/10.2139/ssrn.2951448

Benjamin Bernard

University of California, Los Angeles (UCLA) - Department of Economics ( email )

8283 Bunche Hall
Los Angeles, CA 90095-1477
United States

Agostino Capponi (Contact Author)

Columbia University ( email )

S. W. Mudd Building
New York, NY 10027
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Joseph E. Stiglitz

Columbia Business School - Finance and Economics ( email )

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(212) 662-8474 (Fax)

HOME PAGE: http://www.josephstiglitz.com

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

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