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Resolving banking crises - an analysis of policy options

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  • Misa Tanaka
  • Glenn Hoggarth

Abstract

This paper develops a dynamic model to examine the ex-ante and ex-post implications of five policy options for resolving bank failures when the authorities cannot observe the level of non-performing loans (NPLs) held by individual banks. Under asymmetric information, we show that the first-best outcome is achievable when the authorities can close all banks that fail to raise a minimum level of new capital. But when the authorities cannot close banks and must rely on financial incentives to induce banks to liquidate their NPLs, recapitalisation using equity (Tier 1 capital) would be the second-best policy, whereas recapitalisation using subordinated debt (Tier 2 capital) is suboptimal. If the authorities do not wish to hold an equity stake in a bank, they should subsidise the liquidation of non-performing loans rather than inject subordinated debt. We also show that the cost of this subsidy can be reduced if it is offered in a menu that includes equity injection.

Suggested Citation

  • Misa Tanaka & Glenn Hoggarth, 2006. "Resolving banking crises - an analysis of policy options," Bank of England working papers 293, Bank of England.
    • Handle: RePEc:boe:boeewp:293
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    File URL: http://www.bankofengland.co.uk/research/Documents/workingpapers/2006/WP293.pdf
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    References listed on IDEAS

    as
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    6. Glenn Hoggarth & Jack Reidhill & Peter Sinclair, 2004. "On the resolution of banking crises: theory and evidence," Bank of England working papers 229, Bank of England.
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    Cited by:

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    3. Aikman, David & Nelson, Benjamin & Tanaka, Misa, 2015. "Reputation, risk-taking, and macroprudential policy," Journal of Banking & Finance, Elsevier, vol. 50(C), pages 428-439.
    4. Mark A Carlson & Jonathan Rose, 2016. "Can a bank run be stopped? Government guarantees and the run on Continental Illinois," BIS Working Papers 554, Bank for International Settlements.
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    6. Pandey, Ashish, 2016. "High Bids and Low Recovery: A Possible Case for Non-Performing Loan Auctions in India," MPRA Paper 75254, University Library of Munich, Germany.

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