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Injection of Public Funds into Banks under Deposit Insurance and Bank Regulation

In: Banking, Capital Markets and Corporate Governance

Author

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  • Hiroshi Osano

Abstract

We discuss the optimality of the regulator injecting public funds into a bank in the presence of deposit insurance, and characterise an optimal injection policy to prevent the bank from taking moral hazard action. We show that under certain conditions, the regulator’s optimal policy is to inject new cash funds into the bank. Furthermore, if the regulator does not have enough information on the bank, the regulator can inject public funds into the bank through the purchase of subordinated bonds by setting the interest rate equal to zero; on the other hand, if the regulator has enough information on the bank, the regulator may inject public funds into the bank through the purchase of preferred stocks. However, we also indicate that this kind of injection policy cannot be independent of the bank closure policy of the regulator: inefficient banks should be closed. The author is grateful to Patrick Bolton, Ichiro Ide and Shuji Kobayakawa for helpful comments.

Suggested Citation

  • Hiroshi Osano, 2001. "Injection of Public Funds into Banks under Deposit Insurance and Bank Regulation," Palgrave Macmillan Books, in: Hiroshi Osano & Toshiaki Tachibanaki (ed.), Banking, Capital Markets and Corporate Governance, chapter 4, pages 51-84, Palgrave Macmillan.
    • Handle: RePEc:pal:palchp:978-0-230-28814-0_4
    DOI: 10.1057/9780230288140_4
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    Cited by:

    1. Ishikawa Daisuke, 2003. "Tax-Financed Public Funds Injection into Banks and its Welfare Implications," Discussion Papers in Economics and Business 03-02, Osaka University, Graduate School of Economics.
    2. Osano, Hiroshi, 2002. "Managerial compensation contract and bank bailout policy," Journal of Banking & Finance, Elsevier, vol. 26(1), pages 25-49, January.

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