Bank resolution concepts, trade-offs, and changes in practices

Banks and financial intermediaries perform important roles for the smooth functioning of the economy such as channeling resources from savers to productive projects and providing payment services. Because bank failure can result in significant costs for the economy, an efficient resolution mechanism is needed to mitigate such costs. This article provides a simple framework for analyzing the feasibility and cost of different resolution methods. The analysis shows that while private resolution methods, such as sale to a healthy bank, are preferred options in terms of minimizing costs, they may not be feasible when the distressed institution is large or complex or when its failure occurs during a systemic crisis. Instead, firms and regulators may face second-best solutions, entailing trade-offs between disorderly liquidation and the use of public funds.