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.

JEL Classification: G12, G21, G28.

Keywords: Bank closure, Deposit insurance, Bailouts.

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