DP14244 Optimal Forbearance of Bank Resolution
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.