To Be Bailed Out or To Be Left to Fail? A Dynamic Competing Risks Hazard Analysis.

Abstract

During the late 2000s financial crisis, a large number of banks either failed or received financial aid thus inflicting substantial losses on the system. We contribute to the early warning literature by developing a dynamic competing risks hazard model that explores the joint determination of the probability of a distressed bank to face a licence withdrawal or to be bailed out. The underlying patterns of distress are analysed based on a broad range of bank-level and environmental factors. We find that institutions with inadequate capital, illiquid and risky assets, poor management, low levels of earnings and high sensitivity to market conditions have a higher probability to go bankrupt. Bailed out banks, on the other hand, face both capital and liquidity shortages, experience low earnings, and are highly exposed to market products; however, neither managerial expertise, nor the quality of assets are relevant to the odds of bailout. We further document that large and complex banks are less likely to fail and more likely to be bailed out and that authorities are more prone to provide support to a distressed bank, which is well-connected with politicians and political parties and less prone to let it go bankrupt. Importantly, our model outperforms the commonly used logit model in terms of forecasting accuracy in all the in- and out-of-sample tests we conduct.