Rules versus Discretion in Bank Resolution

52 Pages Posted: 17 Oct 2019

See all articles by Ansgar Walther

Ansgar Walther

University of Warwick - Warwick Business School

Lucy White

Centre for Economic Policy Research (CEPR); Boston University - Department of Finance & Economics

Date Written: October 2019

Abstract

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

Walther, Ansgar and White, Lucy, Rules versus Discretion in Bank Resolution (October 2019). CEPR Discussion Paper No. DP14048. Available at SSRN: https://ssrn.com/abstract=3471242

Ansgar Walther (Contact Author)

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

Lucy White

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

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