Linda Schilling, Utrecht University

"Optimal Forbearance of Bank Resolution"

Abstract

This paper analyzes optimal strategic delay of bank resolution (forbearance). A resolution authority (RA) decides when to optimally intervene while observing bank withdrawals which may accumulate to a bank run. Intervention stops the run during which depositors with- draw to secure also the uninsured part of their deposit at the expense of other depositors and a deposit insurance fund. Early intervention decreases the haircut depositors have to take under resolution, but an early intervention policy increases the belief that resolution occurs, thus depositors run more often which triggers resolution. Efficient forbearance policy further takes into account deposit insurance coverage which impacts whether runs are inefficient or whether inefficient continuation of investment exists and recovery rates under which RA liquidates. Un- der low recovery rates, maximum forbearance is optimal while under higher recovery rates minimum forbearance is optimal. The option to delay is more valuable under high insurance coverage if recovery rates are low but can become less valuable under high coverage when recovery rates are large.

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