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

Siema Hashemi ()
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Siema Hashemi: CEMFI, Centro de Estudios Monetarios y Financieros, https://www.cemfi.es/

Working Papers from CEMFI

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.

Keywords: Bailouts; bail-ins; bank resolution; systemic risk; bank portfolio allocation; fire sales. (search for similar items in EconPapers)
JEL-codes: G21 G28 G33 (search for similar items in EconPapers)
Date: 2024-06
New Economics Papers: this item is included in nep-ban, nep-cba and nep-rmg
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