'Financial Restructuring and Resolution of Banks'
We study how resolution frameworks for failing banks affect the incentives of private stakeholders to restructure the liabilities of a distressed bank before it fails. In our model, a distressed bank’s shareholders and creditors can renegotiate its liabilities, but informational frictions hamper financial restructuring, resulting in delays and depletion of value. The resolution framework affects this process. While excessively lax bail-out rules suppress private restructuring incentives, excessively strict bail-in rules also lead to costly delays: they make the value of debt more information-sensitive, which worsens informational frictions. The government may want to partake in the negotiations to speed up the restructuring process. However, it then has to subsidize the other parties, and strict bail-in rules can in fact weaken its bargaining position.