Too-many-to-fail and the Design of Bailout Regimes

Wolf Wagner () and Jing Zeng ()
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Wolf Wagner: Erasmus University and CEPR
Jing Zeng: University of Bonn and CEPR

No 230, ECONtribute Discussion Papers Series from University of Bonn and University of Cologne, Germany

Abstract: We analyze the design of bailout regimes when investment is distorted by a too-many-to-fail problem. The first-best allocation equalizes benefits from more banks investing in high-return projects with endogenously higher systemic risk due to more banks failing simultaneously. A standard bailout policy cannot implement the first-best, as bailouts cause herding by banks. However, a bailout policy that assigns banks to separate bailout regimes eliminates herding and achieves the first-best. When such a policy is not feasible, targeted bailouts can be implemented by decentralizing bailout decisions to independent regulators. Our results have various implications for the optimal allocation of regulatory powers, both at the international level and domestically.

Keywords: systemic risk; too-many-to-fail; optimal investment; bailouts (search for similar items in EconPapers)
JEL-codes: G1 G2 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2023-05
New Economics Papers: this item is included in nep-ban, nep-cba, nep-des, nep-fdg and nep-rmg
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Citations: View citations in EconPapers (1)

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