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Optimally Solving Banks' Legacy Problems

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Abstract

We characterize policy interventions directed to minimize the cost to the deposit guarantee scheme and the taxpayers of banks with legacy problems. Non-performing loans (NPLs) with low and risky returns create a debt overhang that induces bank owners to forego profitable lending opportunities. NPL disposal requirements can restore the incentives to undertake new lending but, as they force bank owners to absorb losses, can also make them prefer the bank being resolved. For severe legacy problems, combining NPL disposal requirements with positive transfers is optimal and involves no conflict between minimizing the cost to the authority and maximizing overall surplus.

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  • Anatoli Segura & Javier Suarez, 2019. "Optimally Solving Banks' Legacy Problems," Working Papers wp2019_1910, CEMFI.
    • Handle: RePEc:cmf:wpaper:wp2019_1910
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    Cited by:

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    2. Carlos Melo Gouveia, 2019. "Portuguese labour market synthetic indicators," Economic Bulletin and Financial Stability Report Articles and Banco de Portugal Economic Studies, Banco de Portugal, Economics and Research Department.

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    More about this item

    Keywords

    Non performing loans; deposit insurance; debt overhang; optimal intervention; state aid.;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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