Working Paper: NBER ID: w29560
Authors: Thomas Philippon; Olivier Wang
Abstract: We study time-consistent bank resolution mechanisms. When interventions are ex post efficient, a government cannot commit not to inject capital into the banking system. Contrary to common wisdom, we show that the government may still avoid moral hazard and implement the first best allocation by using the distribution of bailouts across banks to provide ex ante incentives. In particular, we analyze properties of credible tournament mechanisms that provide support to the best performing banks and resolve the worst performing ones, including through mergers. Our mechanism continues to perform well if banks are partially substitutable, and if they are heterogeneous in their size, interconnections, and thus systemic risk, as long as bailout funds can be targeted to particular banks.
Keywords: bank resolution; moral hazard; bailouts; systemic risk; tournament mechanisms
JEL Codes: G01; G2; G33; G34; G38; H12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government interventions in bank bailouts (G28) | moral hazard (G52) |
| bailout expectations (G28) | risk-taking behavior (D91) |
| relative performance mechanism for bank bailouts (G28) | first-best allocation (D61) |
| structure of bailouts (G28) | bank performance incentives (G21) |
| fiscal slack (E62) | implementable policies (D78) |
| increased systemic risk (F65) | need for more prudent behavior (G41) |