Bank Bailouts, International Linkages and Cooperation

In: https://ora.ox.ac.uk/objects/uuid:861cc186-8fab-411d-a3ec-314cc1778a7f

Open Access

Abstract

Financial institutions are increasingly linked internationally. As a result, financial crisis and government intervention have stronger effects beyond borders. We provide a model of international contagion allowing for bank bailouts. While a social planner trades off tax distortions, liquidation losses and intra- and intercountry income inequality, in the non-cooperative game between governments there are inefficiencies due to externalities, no burden sharing and free-riding. We show that, in absence of cooperation, stronger interbank linkages make government interests diverge, whereas cross-border asset holdings tend to align them. We analyze different forms of cooperation and their effects on global and national welfare.