A Theory of Bank Resolution: Technological Change and Political Economics
Speaker
Abstract
| We model the failed bank resolution process as a repeated game between a utility-maximizing government resolution authority (RA) and a profit-maximizing banking industry. Limits to resolution technology and political pressures create incentives for the RA to bail out insolvent high-risk banks; the inability of the RA to credibly commit to closing these banks creates an incentive for bank risk-taking. We solve the game in mixed strategies and find equilibrium conditions remarkably descriptive of government responses to actual and potential large bank insolvencies during the recent financial crisis. The central role of the technology constraint in this model highlights a crucial determinant of failed bank resolution policy that has been overlooked in the theory literature to date. The effects of political pressure in this model remind us that regulatory reform (i.e., Dodd-Frank) is only as good as the regulators that must implement the reform. |
| The Erasmus Finance Seminar is jointly sponsored by ERIM and the Tinbergen Institute. |
| Contact information: |
| Viorel Roscovan |
