INCENTIVES AND THE RESOLUTION OF BANK DISTRESS

Abstract

Unlike prudential regulations that are put in place prospectively to develop banks, procedures for dealing with banks in distress are generally determined on an ad hoc basis. Often the lack of clarity in the policy framework creates incentives for bank managers, shareholders, depositors, and regulators that undercut prompt resolution of financial distress. The result is often inaction, the accumulation of bad debts, and ultimately the assumption of losses by the state. This article argues that government intervention to relieve financial distress should be institutionalized in a set of regulations that forces the authorities to comply with reporting and decisionmaking processes. Only in this way can inherent disincentives for dealing with distress be curtailed.