Too many to fail: an analysis of time-inconsistency in bank closure policies

Acharya, V and Yorulmazer, T (2006) Too many to fail: an analysis of time-inconsistency in bank closure policies. Working Paper. London Business School nan.

Abstract

This paper shows that bank closure policies suffer from a "toomanytofail" problem: when the number of bank failures is large, the regulator finds it expost optimal to bail out some or all failed banks, whereas when the number of bank failures is small, failed banks can be acquired by the surviving banks. This gives banks incentives to herd and increases systemic risk, the risk that many banks may fail together. The expost optimal regulation may thus be suboptimal from an exante standpoint. We formalize this timeinconsistency of bank regulation. We also compare toomanytofail problem with toobigtofail problem and show that small banks have stronger incentives to her than large banks.