Too-Many-To-Fail and the Design of Bailout Regimes

Wolf Wagner () and Jing Zeng

CRC TR 224 Discussion Paper Series from University of Bonn and University of Mannheim, Germany

Abstract: We show that the too-many-to-fail problem can be resolved through an appropriate design of the bailout regime. In our model, optimal investment balances benefits from more banks investing in high-return projects against higher systemic costs due to more banks failing simultaneously. Under a standard bailout regime, banks herd, anticipating that simultaneous failures trigger bailouts. However, a policy that prioritizes bailing out a predesignated group of banks eliminates herding and achieves the first-best. If such a policy is not feasible, its benefits can be attained by decentralizing bailout decisions to two regulators each responsible for a separate group of banks.

Keywords: systemic risk; optimal investment; too-many-to-fail; time-consistency; bailouts (search for similar items in EconPapers)
JEL-codes: G1 G2 (search for similar items in EconPapers)
Pages: 53
Date: 2024-11
New Economics Papers: this item is included in nep-cba and nep-rmg
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Working Paper: Too-many-to-fail and the Design of Bailout Regimes (2023)
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