Bank bailouts, bail‐ins, or no regulatory intervention? A dynamic model and empirical tests of optimal regulation and implications for future crises. Issue 4 (1st April 2022)

• Record Type: Journal Article
• Authors: Berger, Allen N.; Himmelberg, Charles P.; Roman, Raluca A.; Tsyplakov, Sergey
• Is Part Of: Financial management. Volume 51:Issue 4(2022)
• Page Start: 1031
• Page End: 1090
• Publication Date: 2022-04-01
• Subjects: bail‐ins -- bailouts -- bankruptcy -- banks -- capital structure -- crises -- dynamic model -- regulation; Corporations -- Finance -- Periodicals; 658.1505
• DOI: 10.1111/fima.12392
• Languages: English
• ISSNs: 0046-3892

Abstract

Abstract: We model dynamic bank capital structure under three optimally‐designed regulatory regimes for dealing with potential default—bailout, in which the government provides capital; bail‐in, which the private‐sector provides needed funds; and no regulatory intervention, allowing the institutions to fail. Only under the optimally‐designed bail‐in regime do banks recapitalize during times of distress. Their pre‐commitment to recapitalize reduces debt costs and increases debt capacity. No regulatory intervention is suboptimal for all agents. Optimal bailouts and bail‐ins both generate no asset substitution‐moral hazard behavior under optimal policies in which regulators intervene at early stages of distress. Empirical tests of changes in capital behavior from the pre‐Global Financial Crisis bailout period to the post‐crisis bail‐in period corroborate the model's predictions.