Optimally Solving Banks' Legacy Problems
66 Pages Posted: 10 Aug 2019
Date Written: June 18, 2019
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 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 resolved. For severe legacy problems, combining NPL disposal requirements with positive transfers is optimal and involves no conflict between minimizing the cost to the authority and maximizing overall surplus.
Keywords: non performing loans, deposit insurance, debt overhang, optimal intervention, state aid
JEL Classification: G01, G20, G28
Suggested Citation: Suggested Citation