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Walking Wounded or Living Dead? Making Banks Foreclose Bad Loans

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  • Max Bruche
  • Gerard Llobet

Abstract

Because of limited liability, insolvent banks have an incentive to roll over bad loans, in order to hide losses and gamble for resurrection, even though this is socially inefficient. We suggest a scheme that regulators could use to solve this problem. The scheme would induce banks to reveal their bad loans, which can then be foreclosed. Bank participation in the scheme would be voluntary. Even though banks have private information on the quantity of bad loans on their balance sheet, the scheme avoids creating windfall gains for bank equity holders. In addition, some losses can be imposed on debt holders.

Suggested Citation

  • Max Bruche & Gerard Llobet, 2011. "Walking Wounded or Living Dead? Making Banks Foreclose Bad Loans," FMG Discussion Papers dp675, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp675
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    Cited by:

    1. Muhammad Umar & Gang Sun, 2016. "Non-performing loans (NPLs), liquidity creation, and moral hazard: Case of Chinese banks," China Finance and Economic Review, Springer, vol. 4(1), pages 1-23, December.
    2. Zhang, Dayong & Cai, Jing & Dickinson, David G. & Kutan, Ali M., 2016. "Non-performing loans, moral hazard and regulation of the Chinese commercial banking system," Journal of Banking & Finance, Elsevier, vol. 63(C), pages 48-60.

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    More about this item

    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
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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