Fries, Steven, Pierre Mella-Barral, William Perraudin, "Optimal Bank Reorganization and the Fair Pricing of Deposit Guarantees", Journal of Banking & Finance, Vol. 21, No. 4, (April 1997), pp. 441-468.
Abstract: When should regulators close a financially ailing bank? FDIC practice in the US has moved in the direction of early closure. In contrast, banking regulators in Japan continue to follow a more patient approach. This paper analyses a series of models in which closure rules and bailout policies arise endogenously through the interaction of (i) regulators' attempts to minimize discounted, expected bankruptcy costs, and (ii) equity-holders' incentives to recapitalise banks. We characterize subsidy policies for distressed banks that implement socially optimal closure rules at minimum financial cost to regulators and which reduce moral hazard.
Keywords: Bank closure, Deposit insurance, Bailouts.