Bank Bailouts, Bail-Ins, or No Regulatory Intervention? A Dynamic Model and Empirical Tests of Optimal Regulation
71 Pages Posted: 24 May 2018 Last revised: 1 Aug 2019
Date Written: July 30, 2019
We develop a dynamic model of bank capital structure under three optimally-designed regulatory regimes to deal with potential bank default. These are bailout, where government provides capital; bail-in, with private-sector funds; and no regulatory intervention, allowing failure. We find that only under optimally-designed bail-in do banks recapitalize during distress. Their pre-commitment to recapitalize reduces debt costs and increases debt capacity. Additionally, no regulatory intervention is suboptimal for all agents relative to other regimes. Empirical tests of changes in bank capital ratios and speeds of adjustment when shifting from the pre-crisis bailout regime to the post-crisis bail-in regime corroborate model predictions.
Keywords: Banks, Bailouts, Bail-Ins, OLA, Bankruptcy, Regulation, Capital Structure
JEL Classification: G21, G28
Suggested Citation: Suggested Citation