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Banking on Resolution: Portfolio Effects of Bail-in vs. Bailout

Author

Listed:
  • Siema Hashemi

    (CEMFI, Centro de Estudios Monetarios y Financieros)

Abstract
This paper investigates the impact of supervisory resolution tools, specifically bail-ins versus bailouts, on the ex-ante banks’ portfolio composition and resulting ex-post default probabilities in the presence of both idiosyncratic and systematic shocks. Banks make decisions regarding short-term versus long-term risky investments while considering the expected resolution policy. I find that both types of shocks can generate financial instability, which the two resolution tools address through distinct channels. With only idiosyncratic shocks, creditor bailouts, acting as debt insurance, eliminate the equilibrium with bank defaults, while bail-ins induce banks to invest less in the risky short-term asset, which may also prevent defaults. In the presence of both shocks, creditor bailouts can prevent systemic defaults, while bail-ins are less effective in preventing them and could even contribute to systemic risk.

Suggested Citation

  • Siema Hashemi, 2024. "Banking on Resolution: Portfolio Effects of Bail-in vs. Bailout," Working Papers wp2024_2410, CEMFI.
    • Handle: RePEc:cmf:wpaper:wp2024_2410
    as

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    File URL: https://www.cemfi.es/ftp/wp/2410.pdf
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    References listed on IDEAS

    as
    1. V. V. Chari & Patrick J. Kehoe, 2016. "Bailouts, Time Inconsistency, and Optimal Regulation: A Macroeconomic View," American Economic Review, American Economic Association, vol. 106(9), pages 2458-2493, September.
    2. Dávila, Eduardo & Walther, Ansgar, 2020. "Does size matter? Bailouts with large and small banks," Journal of Financial Economics, Elsevier, vol. 136(1), pages 1-22.
    3. Allen N. Berger & Charles P. Himmelberg & Raluca A. Roman & Sergey Tsyplakov, 2022. "Bank bailouts, bail‐ins, or no regulatory intervention? A dynamic model and empirical tests of optimal regulation and implications for future crises," Financial Management, Financial Management Association International, vol. 51(4), pages 1031-1090, December.
    4. Wolf Wagner & Jing Zeng, 2023. "Too-many-to-fail and the Design of Bailout Regimes," ECONtribute Discussion Papers Series 230, University of Bonn and University of Cologne, Germany.
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    6. Keister, Todd & Mitkov, Yuliyan, 2023. "Allocating losses: Bail-ins, bailouts and bank regulation," Journal of Economic Theory, Elsevier, vol. 210(C).
    7. Ansgar Walther & Lucy White & Itay Goldstein, 2020. "Rules versus Discretion in Bank Resolution," The Review of Financial Studies, Society for Financial Studies, vol. 33(12), pages 5594-5629.
    8. Dewatripont, Mathias, 2014. "European banking: Bailout, bail-in and state aid control," International Journal of Industrial Organization, Elsevier, vol. 34(C), pages 37-43.
    9. Thomas Philippon & Olivier Wang, 2023. "Let the Worst One Fail: A Credible Solution to the Too-Big-To-Fail Conundrum," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 138(2), pages 1233-1271.
    10. Emmanuel Farhi & Jean Tirole, 2012. "Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts," American Economic Review, American Economic Association, vol. 102(1), pages 60-93, February.
    11. Benjamin Bernard & Agostino Capponi & Joseph E. Stiglitz, 2022. "Bail-Ins and Bailouts: Incentives, Connectivity, and Systemic Stability," Journal of Political Economy, University of Chicago Press, vol. 130(7), pages 1805-1859.
    12. Lorenzo Pandolfi, 2022. "Bail-in and Bailout: Friends or Foes?," Management Science, INFORMS, vol. 68(2), pages 1450-1468, February.
    13. Leanza, Luca & Sbuelz, Alessandro & Tarelli, Andrea, 2021. "Bail-in vs bail-out: Bank resolution and liability structure," International Review of Financial Analysis, Elsevier, vol. 73(C).
    14. Sylvain Benoit & Maroua Riabi, 2020. "Bail-in vs. Bailout: A Persuasion Game," Post-Print hal-04493729, HAL.
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    More about this item

    Keywords

    Bailouts; bail-ins; bank resolution; systemic risk; bank portfolio allocation; fire sales.;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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