Seminario di Bruno Parigi

ORE 12.30 SALA SEMINARI – I° PIANO, PALAZZO LEVI CASES, VIA DEL SANTO 33

20.09.2016

Seminario di Bruno Maria Parigi (University of Padova, and CESifo)

Non-Performing Loans, Under Investment, and Bad Banks

We develop a simple and innovative model to investigate the under investment problem from debt overhang in a banking economy. When the bank discovers the poor performance of its legacy loans and the expected profits from new loans are not sufficient to offset legacy losses, a credit crunch may arise. Segregating the poorly-performing legacy loans and related debt into a separate asset management company, the bad bank, may make it profitable for the bank to make new loans. By setting up a bad bank the shareholder exploits the default option on the bank debt, which he may want to do more often than what is ex-ante socially optimal. We show under which conditions the prohibition of the bad bank increases welfare ex-ante. However, the ex-ante prohibition of the bad bank is not time consistent since in a crisis, i.e. when assets returns are low, it is constrained efficient to allow to invest through a bad bank at the expenses of both the old and the new bondholders.