Working Paper: CEPR ID: DP14244
Authors: Linda Marlene Schilling
Abstract: We analyze optimal strategic delay of bank resolution (\grq forbearance') and deposit insurance coverage. After bad news on the bank's assets, depositors fear for the uninsured part of their deposit and withdraw while the regulator observes withdrawals and needs to decide when to intervene. Optimal policy maximizes the joint value of the demand deposit contract and the insurance fund to avoid inefficient risk-shifting towards the fund while also preventing inefficient runs. Under low insurance coverage, the optimal intervention policy is never to intervene (laissez-faire). Optimal deposit insurance coverage is always interior.The paper sheds light on the differences between the U.S. and the European Monetary Union concerning their bank resolution policies.
Keywords: bank resolution; deposit insurance; global games; suspension of convertibility; bank run; mandatory stay; forbearance; deposit freeze; recovery rates
JEL Codes: G28; G21; G33; D8; E6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| deposit insurance levels (G28) | likelihood of bank runs (E44) |
| timing of intervention by the RA (C41) | depositors' behavior (G21) |
| insurance coverage increases (G52) | likelihood of overinvestment (G31) |
| higher level of deposit insurance coverage (G28) | propensity for depositors to roll over deposits (G21) |
| RA's optimal forbearance policy (H21) | likelihood of inefficient runs (C51) |
| timing of intervention by the RA (C41) | stability of the banking system (G21) |