The Costs of Closing Failed Banks: A Structural Estimation of Regulatory Incentives

We estimate a dynamic model of the decision to close a troubled bank. Regulators trade off an aversion to closing banks against the risk that allowing a bank to continue will raise the eventual costs to the deposit insurance fund. Using a conditional choice probability approach, we estimate the cost...

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Bibliographic Details
Published in:The Review of financial studies 2015-04, Vol.28 (4), p.1060-1102
Main Authors: Kang, Ari, Lowery, Richard, Wardlaw, Malcolm
Format: Article
Language:English
Subjects:
Bank regulation
Banking industry
Banking system
Business closings
Cost estimates
Costs
Decision making models
Deposit insurance
Dynamic models
Financial services
Incentives
Studies
Trade-off
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Summary:We estimate a dynamic model of the decision to close a troubled bank. Regulators trade off an aversion to closing banks against the risk that allowing a bank to continue will raise the eventual costs to the deposit insurance fund. Using a conditional choice probability approach, we estimate the costs associated with closing banks, both in direct costs to the insurance fund and in other costs perceived by regulators, either social or personal. We find that delayed closures were driven by a desire to defer costs, an aversion to closing the largest and smallest troubled banks, and political influence.
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/hhu076