Optimal Bailouts Under Partially Centralized Bank Supervision

This paper examines the optimal degree of centralization that can be achieved with respect to bailout policies when a central authority cannot supervise the entire banking system of the economy. Part of the banking system is supervised by a local authority that can observe local shocks and is biased towards local banks. The paper builds a model of delegation in which a central authority can mandate the contribution of the local authority to bank bailouts as well as the size of the bailout fund. The results derive conditions under which it is optimal for the local authority to be given full autonomy to choose bailout policies, due to its access to private information. The model shows that these conditions become more restrictive if the local authority has the ability to use public debt to increase the size of the bailout fund.