Optimally Solving Banks' Legacy Problems

53 Pages Posted: 13 May 2019 Last revised: 24 Mar 2020

See all articles by Anatoli Segura

Anatoli Segura

Bank of Italy

Javier Suarez

Centre for Monetary and Financial Studies (CEMFI); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

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Date Written: May 2019

Abstract

We characterize policy interventions directed to minimize the cost to the deposit guarantee scheme and the taxpayers of banks with legacy problems. Non-performing loans (NPLs) with low and risky returns create a debt overhang that induces bank owners to forego profitable lending opportunities. NPL disposal and provisioning requirements can restore the incentives to undertake new lending but, as they force bank owners to absorb losses, can also make them prefer the bank being liquidated. For severe legacy problems, combining those NPL-targeted interventions with positive transfers is optimal and involves no conflict between minimizing the cost to the authority and maximizing overall surplus.

Keywords: Debt overhang, deposit insurance, non performing loans, optimal intervention, state aid

JEL Classification: G01, G20, G28

Suggested Citation

Segura, Anatoli and Suarez, Javier, Optimally Solving Banks' Legacy Problems (May 2019). CEPR Discussion Paper No. DP13718, Available at SSRN: https://ssrn.com/abstract=3387307

Anatoli Segura (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Javier Suarez

Centre for Monetary and Financial Studies (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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