Bank Recapitalization and Restructuring: An Economic Analysis of Various Options

A financial crisis leads to a debt overhang in the banking sector and subsequently to a credit crunch. In most cases, it is not possible to remedy this situation without economic policy measures. In this study, we use a uniform framework to analyze how banks in a crisis situation can be restructured at minimum cost to the taxpayer in order to enable them to function again. We discuss various forms of intervention: measures which do not affect the rights of existing bank owners and creditors (guaranteeing prior debts, purchasing troubled assets, injecting equity) and measures that do (good bank/bad bank, debt-for-equity swap). Measures which minimize the costs to the taxpayer will necessarily affect the rights of existing owners and creditors, meaning that they also raise issues related to the reform of bank insolvency law.