Too Many to Fail - an Analysis of Time Inconsistency in Bank Closure Policies

32 Pages Posted: 6 Mar 2005

See all articles by Viral V. Acharya

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Tanju Yorulmazer

Koc University

Multiple version iconThere are 3 versions of this paper

Date Written: December 2004

Abstract

This Paper shows that bank closure policies suffer from a 'too-many-to-fail' problem: when the number of bank failures is large, the regulator finds it ex-post optimal to bail out some or all failed banks, whereas when the number of bank failures is small, failed banks can be acquired by the surviving banks. This gives banks incentives to herd and increases systemic risk, the risk that many banks may fail together. The ex-post optimal regulation may thus be sub-optimal from an ex-ante standpoint. We formalize this time-inconsistency of bank regulation. We also argue that by allowing banks to purchase failed banks at discounted prices and by partially nationalizing the bailed-out banks, a regulator may be able to mitigate the induced systemic risk.

Keywords: Bank regulation, systemic risk, bailout, moral hazard, herding

JEL Classification: D62, E58, G21, G28, G38

Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Yorulmazer, Tanju, Too Many to Fail - an Analysis of Time Inconsistency in Bank Closure Policies (December 2004). Available at SSRN: https://ssrn.com/abstract=667904

Viral V. Acharya (Contact Author)

New York University (NYU) - Leonard N. Stern School of Business ( email )

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HOME PAGE: http://www.stern.nyu.edu/~vacharya

New York University (NYU) - Department of Finance ( email )

Stern School of Business
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Centre for Economic Policy Research (CEPR) ( email )

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European Corporate Governance Institute (ECGI) ( email )

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National Bureau of Economic Research (NBER) ( email )

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Tanju Yorulmazer

Koc University ( email )

Rumeli Feneri Yolu
Sariyer, Istanbul, 34450
Turkey

HOME PAGE: http://gsssh.ku.edu.tr/en/departments/economics/akademik-kadro/show/tyorulmazer/

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