 Too big to fail and optimal regulationChang Ma and Xuan-Hai Nguyen International Review of Economics & Finance, 2021, vol. 75, issue C, 747-758 Abstract: This paper analyzes the optimal regulation for “Too Big to Fail” (TBTF) in a simple model. As the government cannot credibly commit to no bail-out during crises, banks have an incentive to become excessively large ex-ante. In this case, no single policy can fully eliminate the inefficiencies from TBTF. The optimal regulation for the first-best allocation features a capital requirement and an issuance of Contingent Convertible Bonds (CoCos) where the former addresses the moral hazard issue from government bailouts and the latter improves risk-sharing. Moreover, a combination of the capital requirement and size regulation can implement a second-best allocation where the government has to bail out the banking sector but the social cost of bail-out is internalized by the banks. In this case, the capital requirement forces banks to internalize the bailout cost while the size regulation directly discourages banks to become large. Keywords: Too big to fail; Bailout; Optimal regulation; CoCos (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:75:y:2021:i:c:p:747-758 DOI: 10.1016/j.iref.2021.04.032 Access Statistics for this article International Review of Economics & Finance is currently edited by H. Beladi and C. Chen More articles in International Review of Economics & Finance from Elsevier |
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