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The optimal bailout policy in an interbank network

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  • Sim, Khai Zhi

Abstract

This paper introduces a theoretical model to analyze the optimal bailout policy in an interconnected banking system. The model intends to highlight two motivations behind providing a partial bailout to banks in distress: prevention of costly bankruptcies and prevention of financial contagion. In the extreme cases where the cost of bailout is sufficiently high or low, the zero-bailout policy or the full-bailout policy is optimal respectively. Otherwise, a partial bailout policy is optimal. The fiscal authority has to balance the benefits of bailouts from bankruptcy and contagion prevention against the cost when it decides on the amount of partial bailout to provide to banks.

Suggested Citation

  • Sim, Khai Zhi, 2022. "The optimal bailout policy in an interbank network," Economics Letters, Elsevier, vol. 216(C).
    • Handle: RePEc:eee:ecolet:v:216:y:2022:i:c:s0165176522001987
    DOI: 10.1016/j.econlet.2022.110628
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    References listed on IDEAS

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    More about this item

    Keywords

    Bank run; Bailout; Interbank network; Contagion; Fiscal policy;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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