Job market paper

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

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 taking into account 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.

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