INCENTIVES AND THE RESOLUTION OF BANK DISTRESS

Unlike prudential regulations that are put in place prospectively to d evelop banks, Procedures for dealing with banks in distress are genera lly determined on an ad hoc basis. Often the lack of clarity in the po licy framework creates incentives for bank managers, shareholders, dep ositors, and regulators that undercut prompt resolution of financial d istress. The result is often inaction, the accumulation of bad debts, and ultimately the assumption of losses by the state. This article arg ues that government intervention to relieve financial distress should be institutionalized in a set of regulations that forces the authoriti es to comply with reporting and decisionmaking processes. Only in this way can inherent disincentives for dealing with distress be curtailed .