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Liquidation, Bailout, and Bail-In: Insolvency Resolution Mechanisms and Bank Lending

Published online by Cambridge University Press:  15 August 2022

Bart M. Lambrecht Open the ORCID record for Bart M. Lambrecht [Opens in a new window]  and
Alex S. L. Tse
Bart M. Lambrecht*
Affiliation:
Cambridge Judge Business School and CEPR
Alex S. L. Tse
Affiliation:
University College London [email protected]
*
[email protected] (corresponding author)
Rights & Permissions [Opens in a new window]

Abstract

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We present a dynamic, continuous-time model in which risk averse inside equityholders set a bank’s lending, payout, and financing policies, and the exposure of bank assets to crashes. We examine whether bailouts encourage excessive lending and risk taking compared to liquidation or bail-ins with debt-to-equity conversion or debt write-downs. The effects of the prevailing insolvency resolution mechanism (IRM) on the probability of insolvency, loss in default, and the bank’s value suggest no single IRM is a panacea. We show how a bailout fund financed through a tax on bank dividends resolves bailouts without public money and without distorting insiders’ incentives.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 58 , Issue 1 , February 2023 , pp. 175 - 216
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank Mark Flannery, Jarrad Harford (the editor), Erwan Morellec (the referee), our discussants (Simon Gleeson, Robert Marquez, John Nash), seminar participants at the Toulouse School of Economics, Bangor University, University of Bath, University of Exeter, and participants at the 2018 BAFA Corporate Finance and Asset Pricing Symposium, the 2019 CERF Cavalcade, the International Finance Symposium, the 2018 SFS Cavalcade Asia-Pacific, the 2018 Rome International Conference on Money, Banking and Finance, the 2019 WFA meetings, and CERF in the City for helpful comments and discussions. Financial support from the JM Keynes Fellowship for Lambrecht and from the Cambridge Endowment for Research in Finance (CERF) for both authors is gratefully acknowledged.

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