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Banking on Resolution: Portfolio Effects of Bail-in vs. Bailout

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  • Siema Hashemi

    (CEMFI, Centro de Estudios Monetarios y Financieros)

Abstract

This paper investigates the impact of supervisory resolution tools, specifically bail-ins versus bailouts, on the ex-ante banks’ portfolio composition and resulting ex-post default probabilities in the presence of both idiosyncratic and systematic shocks. Banks make decisions regarding short-term versus long-term risky investments while considering the expected resolution policy. I find that both types of shocks can generate financial instability, which the two resolution tools address through distinct channels. With only idiosyncratic shocks, creditor bailouts, acting as debt insurance, eliminate the equilibrium with bank defaults, while bail-ins induce banks to invest less in the risky short-term asset, which may also prevent defaults. In the presence of both shocks, creditor bailouts can prevent systemic defaults, while bail-ins are less effective in preventing them and could even contribute to systemic risk.

Suggested Citation

  • Siema Hashemi, 2024. "Banking on Resolution: Portfolio Effects of Bail-in vs. Bailout," Working Papers wp2024_2410, CEMFI.
    • Handle: RePEc:cmf:wpaper:wp2024_2410
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    References listed on IDEAS

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    More about this item

    Keywords

    Bailouts; bail-ins; bank resolution; systemic risk; bank portfolio allocation; fire sales.;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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