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

49 Pages Posted: 6 Sep 2017

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)

Multiple version iconThere are 2 versions of this paper

Date Written: August 2017

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 benefits 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 diversification 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.

Suggested Citation

Bernard, Benjamin and Capponi, Agostino and Stiglitz, Joseph E., Bail-Ins and Bail-Outs: Incentives, Connectivity, and Systemic Stability (August 2017). NBER Working Paper No. w23747. Available at SSRN: https://ssrn.com/abstract=3031718

Benjamin Bernard (Contact Author)

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

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Agostino Capponi

Columbia University ( email )

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Joseph E. Stiglitz

Columbia Business School - Finance and Economics ( email )

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

National Bureau of Economic Research (NBER) ( email )

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