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CEP discussion paper
Bank Bailouts, International Linkages and Cooperation
Friederike Niepmann and Tim Schmidt-Eisenlohr
November 2010
Paper No' CEPDP1023:
Full Paper (pdf)

JEL Classification: F31; F41

Tags: portfolio choice; international transmission of shocks; monetary policy

Financial institutions are increasingly linked internationally. As a result, financial crisis and government intervention have stronger effects beyond borders. We provide a model of international contagion allowing for bank bailouts. While a social planner trades off tax distortions, liquidation losses and intra- and intercountry income inequality, in the noncooperative game between governments there are inefficiencies due to externalities, no burden sharing and free-riding. We show that, in absence of cooperation, stronger interbank linkages make government interests diverge, whereas cross-border asset holdings tend to align them. We analyze different forms of cooperation and their effects on global and national welfare.