Optimal bailouts and the doom loop with a financial network

Capponi, Agostino; Corell, Felix; Stiglitz, Joseph E.

doi:10.1016/j.jmoneco.2022.03.004

Cited by 10 publications

(1 citation statement)

References 43 publications

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“…For instance,Capponi et al (2022) find that governments should bailout banks that have a high 'network centrality' and Acharya et al (2014) derive conditions under which the ex post optimal bailout is non-zero.…”

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confidence: 99%

Optimal Bailouts in Banking and Sovereign Crises

Hur,

Sosa-Padilla,

Yom

2024

gwp

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We study optimal bailout policies amidst banking and sovereign crises. Our model features sovereign borrowing with limited commitment, where domestic banks hold government debt and extend credit to the private sector. Bank capital shocks can trigger banking crises, prompting the government to consider extending guarantees over bank assets. This poses a trade-off: Larger bailouts relax financial frictions and increase output, but increase fiscal needs and default risk (creating a 'diabolic loop'). Optimal bailouts exhibit clear properties. The fraction of banking losses the bailouts cover is (i) decreasing in government debt; (ii) increasing in aggregate productivity; and (iii) increasing in the severity of banking crises. Even though bailouts mitigate the adverse effects of banking crises, the economy is ex ante better off without bailouts: Having access to bailouts lowers the cost of defaults, which in turn increases the default frequency, and reduces the levels of debt, output, and consumption.

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confidence: 99%

Optimal Bailouts in Banking and Sovereign Crises

Hur,

Sosa-Padilla,

Yom

2024

gwp

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The diabolic loop between sovereign and banking risks in the euro area

Gómez‐Puig

Sosvilla‐Rivero

2023

Reference Module in Social Sciences

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An AI approach for managing financial systemic risk via bank bailouts by taxpayers

2022

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Bank bailouts are controversial governmental decisions, putting taxpayers’ money at risk to avoid a domino effect through the network of claims between financial institutions. Yet very few studies address quantitatively the convenience of government investments in failing banks from the taxpayers’ standpoint. We propose a dynamic financial network framework incorporating bailout decisions as a Markov Decision Process and an artificial intelligence technique that learns the optimal bailout actions to minimise the expected taxpayers’ losses. Considering the European global systemically important institutions, we find that bailout decisions become optimal only if the taxpayers’ stakes exceed some critical level, endogenously determined by all financial network’s characteristics. The convenience to intervene increases with the network’s distress, taxpayers’ stakes, bank bilateral credit exposures and crisis duration. Moreover, the government should optimally keep bailing-out banks that received previous investments, creating moral hazard for rescued banks that could increase their risk-taking, reckoning on government intervention.

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Optimal bailouts and the doom loop with a financial network

Cited by 10 publications

References 43 publications

Optimal Bailouts in Banking and Sovereign Crises

Optimal Bailouts in Banking and Sovereign Crises

The diabolic loop between sovereign and banking risks in the euro area

An AI approach for managing financial systemic risk via bank bailouts by taxpayers

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