Bail-Ins and Bailouts: Incentives, Connectivity, and Systemic Stability

Benjamin Bernard, Agostino Capponi and Joseph Stiglitz

Journal of Political Economy, 2022, vol. 130, issue 7, 1805 - 1859

Abstract: This paper endogenizes intervention in financial crises as the strategic negotiation between a regulator and creditors of distressed banks. Incentives for banks to contribute to a voluntary bail-in arise from their exposure to financial contagion. In equilibrium, a bail-in is possible only if the regulator’s threat to not bail out insolvent banks is credible. Contrary to models without intervention or with government bailouts only, sparse networks enhance welfare for two main reasons: they improve the credibility of the regulator’s no-bailout threat for large shocks, and they reduce free-riding incentives among bail-in contributors when the threat is credible.

Date: 2022
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Related works:
Working Paper: Bail-ins and Bail-outs: Incentives, Connectivity, and Systemic Stability (2019)
Working Paper: Bail-ins and Bail-outs: Incentives, Connectivity, and Systemic Stability (2017)
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