Bailout Bifurcation

Wolf Wagner and Jing Zeng

No 19976, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We show that bifurcating bailouts eliminates systemic herding. In our model, the first best requires investment in separate projects to reduce systemic costs from correlated failures. Bailouts that treat all failing banks equally cause banks to herd on a project, anticipating that joint failures trigger support. Bailouts that prioritize predesignated banks eliminate herding by making bailout expectations heterogeneous. A financial architecture with two “home-biased†regulators achieves similar benefits. Our analysis offers a novel rationale for differentiated access to the public safety net, such as for traditional versus shadow banks, or among groups of traditional banks.

JEL-codes: G1 G2 (search for similar items in EconPapers)
Date: 2025-02
New Economics Papers: this item is included in nep-des and nep-rmg
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