Bailouts and Systemic Insurance

We revisit the link between bailouts and bank risk taking. Bailout expectations create moral hazard increase bank risk taking. However, when a banks success depends on both its eort and the overall stability of the banking system, bailouts that shield banks from contagion may increase their incentives to invest prudently and so reduce bank risk taking. This systemic insurance eect is more important when bailout rents are low while contagion risk is high. The optimal policy may then be not to make bailouts di cult, but to make them eective: associated with lower rents.