Optimal Macroprudential Policy with Preemptive Bailouts

Aliaksandr Zaretski

No 325, School of Economics Discussion Papers from School of Economics, University of Surrey

Abstract: I study the optimal regulation of a financial sector where individual banks face self-enforcing constraints countering their default incentives. The constrained-efficient social planner can improve over the unregulated equilibrium in two dimensions. First, by internalizing the impact of banks’ portfolio decisions on the prices of assets and liabilities that affect the enforcement constraints. Second, by redistributing future net worth from new entrants to surviving banks, which increases the current forward-looking value of all banks, relaxing their enforcement constraints and decreasing the probability of banking crises. The latter can be accomplished with systemic preemptive bailouts that are time consistent and unambiguously welfare improving. Unregulated banks can be both overleveraged and underleveraged depending on the state of the economy, thus macroprudential policy requires both taxes and subsidies, while minimum bank capital requirements are generally ineffective.

JEL-codes: E44 E60 G21 G28 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2025-04
New Economics Papers: this item is included in nep-dge, nep-fdg and nep-rmg
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Working Paper: Optimal macroprudential policy with preemptive bailouts (2025)
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Persistent link: https://EconPapers.repec.org/RePEc:sur:surrec:0325

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