Bailouts, monitoring, and penalties: an integrated framework of government policies to manage the too-big-to-fail problem

Gong, Ning and Jones, Kenneth D. 2013, Bailouts, monitoring, and penalties: an integrated framework of government policies to manage the too-big-to-fail problem, International review of finance, vol. 13, no. 3, pp. 299-325, doi: 10.1111/irfi.12011.

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Title Bailouts, monitoring, and penalties: an integrated framework of government policies to manage the too-big-to-fail problem
Author(s) Gong, NingORCID iD for Gong, Ning orcid.org/0000-0001-6454-7572
Jones, Kenneth D.
Journal name International review of finance
Volume number 13
Issue number 3
Start page 299
End page 325
Total pages 27
Publisher Wiley
Place of publication Richmond, Vic.
Publication date 2013-09-01
ISSN 1369-412X
1468-2443
Summary This paper discusses optimal government bailout policy where the costs of systemic failures and moral hazard problems are considered. We find that a three-tiered bailout policy that includes an ex post monitoring and bailout scheme for financial institutions with large systemic impacts ('too big to fail') is optimal. The optimal policy also requires a randomized bailout for medium-impact institutions ('Constructive Ambiguity'), and no bailout for institutions that have only minimal systemic consequences ('too small to save'). However, in a volatile, innovative market environment where individual institutions may know more than the government regulator, monitoring error could contribute to risk taking, leaving the government regulator to always play a 'catch-up' role in revising policy. Moreover, the optimal bailout policy may not be time-consistent: institutions not deemed 'too big to fail' may still have an incentive to take excessive risks and expect to be bailed out in case of insolvency, primarily due to the short-term orientation of the government. Finally, because an institution's systemic cost affects the probability of a bailout, we show that the boundary of an institution may be extended by the government subsidy.
Language eng
DOI 10.1111/irfi.12011
Field of Research 150203 Financial Institutions (incl Banking)
1502 Banking, Finance And Investment
Socio Economic Objective 900101 Finance Services
HERDC Research category C1.1 Refereed article in a scholarly journal
ERA Research output type C Journal article
Copyright notice ©2013, International Review of Finance
Persistent URL http://hdl.handle.net/10536/DRO/DU:30088294

Document type: Journal Article
Collections: Faculty of Business and Law
Department of Finance
2018 ERA Submission
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