Injection of Public Funds into Banks under Deposit Insurance and Bank Regulation

Hiroshi Osano

Chapter 4 in Banking, Capital Markets and Corporate Governance, 2001, pp 51-84 from Palgrave Macmillan

Abstract: Abstract We discuss the optimality of the regulator injecting public funds into a bank in the presence of deposit insurance, and characterise an optimal injection policy to prevent the bank from taking moral hazard action. We show that under certain conditions, the regulator’s optimal policy is to inject new cash funds into the bank. Furthermore, if the regulator does not have enough information on the bank, the regulator can inject public funds into the bank through the purchase of subordinated bonds by setting the interest rate equal to zero; on the other hand, if the regulator has enough information on the bank, the regulator may inject public funds into the bank through the purchase of preferred stocks. However, we also indicate that this kind of injection policy cannot be independent of the bank closure policy of the regulator: inefficient banks should be closed. The author is grateful to Patrick Bolton, Ichiro Ide and Shuji Kobayakawa for helpful comments.

Keywords: Public Fund; Moral Hazard; Deposit Insurance; Threshold Point; Incentive Compatibility Constraint (search for similar items in EconPapers)
Date: 2001
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Persistent link: https://EconPapers.repec.org/RePEc:pal:palchp:978-0-230-28814-0_4

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DOI: 10.1057/9780230288140_4

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