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
Date Written: May 12, 2021
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: Suggested Citation