Resolutions in a system of financially linked firms: relying on coarse information

Gabrielle Demange

PSE Working Papers from HAL

Abstract: In a financial system, firms hold debts both within and outside the system.To limit miscoordination and cascades of defaults, an orderly resolution must be conducted at the system level and simultaneously liquidate all debts. This paper analyzes such resolutions under two main assumptions. First, a default on external creditors, say on banks' customers, triggers bankruptcy and should be avoided as much as possible because of large negative externalities. Second, resolutions are coarse, as they specify the payments between each firm and its external creditors and the system without specifying the reimbursement of each bilateral liability. I present properties that determine which firms become bankrupt and how much each non-bankrupt firm reimburses to and receives from the system. The main properties rely on the priority of external creditors at the system level, which reflects the policy recommendations after the 2018 financial crisis, and the proportionality principle.

Keywords: cross-liabilities; defaults; bankruptcy; resolution; proportionality (search for similar items in EconPapers)
Date: 2025-07
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