This paper focuses on the recapitalization of failing banks. A
recapitalization is efficient if the social benefits (preserving
systemic stability) exceed the cost of recapitalization. In a
national setting, the implementation of an optimal policy is
relatively straightforward. But in a cross-border setting, one is
confronted with possible coordination failure. Using a multicountry
model, it is shown that ex post negotiations on burden sharing lead
to an underprovision of recapitalizations. Next, we explore
different ex ante burden sharing mechanisms to overcome the
coordination failure. The first is a general scheme financed
collectively by the participating countries (generic burden
sharing). The second relates the burden to the location of the
assets of the bank to be recapitalized (specific burden sharing).
The working of the two mechanisms is calibrated with data on large
cross border banks in Europe. Because the costs and benefits are
better aligned in the specific scheme, it is better able to
overcome the coordination failure.
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