{"title":"Too Big to Fail and Optimal Regulation","authors":"Chang Ma, Hai Nguyen","doi":"10.2139/ssrn.2724909","DOIUrl":null,"url":null,"abstract":"Abstract This paper analyzes the optimal regulation for “Too Big to Fail” (TBTF) in a simple model. As the government cannot credibly commit to no bail-out during crises, banks have an incentive to become excessively large ex-ante. In this case, no single policy can fully eliminate the inefficiencies from TBTF. The optimal regulation for the first-best allocation features a capital requirement and an issuance of Contingent Convertible Bonds (CoCos) where the former addresses the moral hazard issue from government bailouts and the latter improves risk-sharing. Moreover, a combination of the capital requirement and size regulation can implement a second-best allocation where the government has to bail out the banking sector but the social cost of bail-out is internalized by the banks. In this case, the capital requirement forces banks to internalize the bailout cost while the size regulation directly discourages banks to become large.","PeriodicalId":221700,"journal":{"name":"Financial Crisis","volume":"77 1","pages":"0"},"PeriodicalIF":0.0000,"publicationDate":"2019-08-29","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":"7","resultStr":null,"platform":"Semanticscholar","paperid":null,"PeriodicalName":"Financial Crisis","FirstCategoryId":"1085","ListUrlMain":"https://doi.org/10.2139/ssrn.2724909","RegionNum":0,"RegionCategory":null,"ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":null,"EPubDate":"","PubModel":"","JCR":"","JCRName":"","Score":null,"Total":0}
引用次数: 7
Abstract
Abstract This paper analyzes the optimal regulation for “Too Big to Fail” (TBTF) in a simple model. As the government cannot credibly commit to no bail-out during crises, banks have an incentive to become excessively large ex-ante. In this case, no single policy can fully eliminate the inefficiencies from TBTF. The optimal regulation for the first-best allocation features a capital requirement and an issuance of Contingent Convertible Bonds (CoCos) where the former addresses the moral hazard issue from government bailouts and the latter improves risk-sharing. Moreover, a combination of the capital requirement and size regulation can implement a second-best allocation where the government has to bail out the banking sector but the social cost of bail-out is internalized by the banks. In this case, the capital requirement forces banks to internalize the bailout cost while the size regulation directly discourages banks to become large.