Rules versus Discretion in Bank Resolution
52 Pages Posted: 17 Oct 2019
Date Written: October 2019
Recent reforms give regulators broad powers to "bail-in" bank creditors during financial crises. We analyze efficient bail-ins and their implementation. To preserve liquidity, regulators must avoid signalling negative private information to creditors. Therefore, optimal bail-ins in bad times depend only on public information. As a result, the optimal policy cannot be implemented if regulators have wide discretion, due to an informational time-inconsistency problem. Rules mandating tough bail-ins after bad public signals, or contingent convertible (co-co) bonds, improve welfare. We further show that bail-in and bailout policies are complementary: if bailouts are possible, then discretionary bail-ins are more effective.
Keywords: bail-in, bail-out, bank resolution, bank runs, financial crises
JEL Classification: G01, G18, G21
Suggested Citation: Suggested Citation