Opacity, signaling, and bail-ins

Abstract

Should banks be transparent during a bail-in? Banks suffering losses may bail-in creditors to optimally allocate resources between early and late withdrawers. However, if losses are private information, then bail-ins may signal asset quality. In the absence of signaling, banks can sell assets at a pooled price, effectively insuring creditors against asset risks. However, when bail-ins signal quality, banks may delay bail-ins and sell assets at higher prices than otherwise, but this incentive can trigger inefficient bank runs. To prevent such runs, banks should choose to be either fully transparent or entirely opaque, ensuring asset quality is not private information.