Collective Moral Hazard and the Interbank Market

Optimal bailouts and the doom loop with a financial network

“…For example, Bernard et al (2022) study under which conditions the government can credibly commit to organize an incentive-compatible bail-in in which solvent banks contribute to rescuing the defaulting banks. Altinoglu and Stiglitz (2020) show how systemically important institutions can emerge as a result of banks expecting a public bailout. Erol (2019) shows that the expectation of bailouts leads to higher connectivity and a core-periphery network structure.…”