Catch, Restrict, and Release: The Real Story of Bank Bailouts

Abstract

Bank bailouts are not the one-shot events commonly described in the literature. These bailouts are instead dynamic processes in which regulators catch financially distressed banks; restrict their activities over time; and release the banks from restrictions at sufficiently healthy capital ratios. The catch-restrict-release approach is a global phenomenon, which we document using hand-collected data on capital injection and debt guarantee bailouts in the European Union (EU) over 2008-2014. We present a dynamic theoretical model of socially-optimizing regulators engaging in catch-restrict-release capital injection and debt guarantee bailouts, and empirically test model predictions. Observed EU bailouts are qualitatively consistent with optimizing behavior.