Let the Worst One Fail: A Credible Solution to the Too-Big-To-Fail Conundrum

Thomas Philippon () and Olivier Wang

No 29560, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We study time-consistent bank resolution mechanisms. When interventions are ex post efficient, a government cannot commit not to inject capital into the banking system. Contrary to common wisdom, we show that the government may still avoid moral hazard and implement the first best allocation by using the distribution of bailouts across banks to provide ex ante incentives. In particular, we analyze properties of credible tournament mechanisms that provide support to the best performing banks and resolve the worst performing ones, including through mergers. Our mechanism continues to perform well if banks are partially substitutable, and if they are heterogeneous in their size, interconnections, and thus systemic risk, as long as bailout funds can be targeted to particular banks.

JEL-codes: G01 G2 G33 G34 G38 H12 (search for similar items in EconPapers)
Date: 2021-12
New Economics Papers: this item is included in nep-ban, nep-cba, nep-fdg and nep-mic
Note: AP CF EFG
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Citations: View citations in EconPapers (6)

Published as Thomas Philippon & Olivier Wang, 2023. "Let the Worst One Fail: A Credible Solution to the Too-Big-To-Fail Conundrum," The Quarterly Journal of Economics, vol 138(2), pages 1233-1271.

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