Government interventions in banking crises: effects of alternative schemes on bank lending and risk taking

We analyse the effects of policy measures to stop the fall in loan supply follow-ing a banking crisis. We apply a dynamic framework in which a debt overhang induces banks to curtail lending or choose a fragile capital structure. Govern-ment assistance conditional on new banking activities, like on new lending or on debt and equity issues, allow banks to influence the scale of assistance and exter-nalise risks, implying overinvestment or excessive risk taking or both. Assistance without reference to new activities, like granting lump sum transfers or establish-ing bad banks, does not generate adverse incentives, but may have higher fiscal costs.