Optimal bank reorganization and the fair pricing of deposit guarantees

When should regulators close a financially ailing bank? FDIC practice in the US has moved in the direction of early closure. In contrast, banking regulators in Japan continue to follow a more patient approach. This paper analyses a series of models in which closure rules and bailout policies arise endogenously through the interaction of (i) regulators' attempts to minimize discounted, expected bankruptcy costs, and (ii) equity-holders' incentives to recapitalise banks. We characterize subsidy policies for distressed banks that implement socially optimal closure rules at minimum financial cost to regulators and which reduce moral hazard.