This paper develops a model to analyze two different bad bank schemes, an outright sale of toxic assets to a state-owned bad bank and a repurchase agreement between the bad bank and the initial bank. For both schemes, we derive a critical transfer payment that induces a bank manager to participate. Participation improves the bank's solvency and enables the bank to grant new loans. Therefore, both schemes can reestablish stability and avoid a credit crunch. An outright sale will be less costly to taxpayers than a repurchase agreement if the transfer payment is sufficiently low.
- Bad banks
- Financial crisis
- Financial stability
- Credit crunch
Hauck, A., Neyer, U., & Vieten, T. (2015). Reestablishing stability and avoiding a credit crunch: Comparing different bad bank schemes. Quarterly Review of Economics and Finance, 57, 116-128. https://doi.org/10.1016/j.qref.2014.10.002