Liquidation, Bailout, and Bail-in: Insolvency Resolution Mechanisms and Bank Lending

Forthcoming in the Journal of Financial and Quantitative Analysis

62 Pages Posted: 22 Feb 2018 Last revised: 26 May 2021

See all articles by Bart M. Lambrecht

Bart M. Lambrecht

University of Cambridge - Judge Business School; Centre for Economic Policy Research (CEPR)

Alex S. L. Tse

University College London

Multiple version iconThere are 2 versions of this paper

Date Written: May 12, 2021

Abstract

We present a dynamic, continuous-time model in which risk averse inside equityholders set a bank's lending, payout, and financing policies, and the exposure of bank assets to crashes. We examine whether bailouts encourage excessive lending and risk-taking compared to liquidation or bail-ins with debt-to-equity conversion or debt write-downs. The effects of the prevailing insolvency resolution mechanism (IRM) on the probability of insolvency, loss in default, and the bank’s value suggest no single IRM is a panacea. We show how a bailout fund financed through a tax on bank dividends resolves bailouts without public money and without distorting insiders' incentives.

Keywords: Liquidation, bailout, bail-in, asset sale, agency

JEL Classification: G33, H81, G34, G32

Suggested Citation

Lambrecht, Bart and Tse, Alex S. L., Liquidation, Bailout, and Bail-in: Insolvency Resolution Mechanisms and Bank Lending (May 12, 2021). Forthcoming in the Journal of Financial and Quantitative Analysis, Available at SSRN: https://ssrn.com/abstract=3123170 or http://dx.doi.org/10.2139/ssrn.3123170

Bart Lambrecht (Contact Author)

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom
44-(0)-1223-339700 (Phone)
44-(0)-1223-339701 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Alex S. L. Tse

University College London ( email )

Gower Street
London, WC1E 6BT
United Kingdom

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