Resolving banking crises - an analysis of policy options

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 09 March 2006

Working Paper No. 293
By Misa Tanaka and Glenn Hoggarth

This paper develops a dynamic model to examine the ex-ante and ex-post implications of five policy options for resolving bank failures when the authorities cannot observe the level of non-performing loans (NPLs) held by individual banks. Under asymmetric information, we show that the first-best outcome is achievable when the authorities can close all banks that fail to raise a minimum level of new capital. But when the authorities cannot close banks and must rely on financial incentives to induce banks to liquidate their NPLs, recapitalisation using equity (Tier 1 capital) would be the second-best policy, whereas recapitalisation using subordinated debt (Tier 2 capital) is suboptimal. If the authorities do not wish to hold an equity stake in a bank, they should subsidise the liquidation of non-performing loans rather than inject subordinated debt. We also show that the cost of this subsidy can be reduced if it is offered in a menu that includes equity injection.

PDFResolving banking crises — an analysis of policy options

 

Other papers

Was this page useful?
Add your details...