DP14244 Optimal Forbearance of Bank Resolution

Author(s): Linda Marlene Schilling
Publication Date: December 2019
Keyword(s): bank resolution, bank run, deposit freeze, deposit insurance, Forbearance, global games, mandatory stay, Recovery Rates, suspension of convertibility
JEL(s): D8, E6, G21, G28, G33
Programme Areas: Financial Economics, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14244

We analyze optimal strategic delay of bank resolution ('grq forbearance') and deposit insurance coverage. After bad news on the bank's assets, depositors fear for the uninsured part of their deposit and withdraw while the regulator observes withdrawals and needs to decide when to intervene. Optimal policy maximizes the joint value of the demand deposit contract and the insurance fund to avoid inefficient risk-shifting towards the fund while also preventing inefficient runs. Under low insurance coverage, the optimal intervention policy is never to intervene (laissez-faire). Optimal deposit insurance coverage is always interior. The paper sheds light on the differences between the U.S. and the European Monetary Union concerning their bank resolution policies.