Bailouts' Design for Financial Institutions

<p>Banking sector is one of the key elements of the financial system both in emerging and developed markets. Its stability is a prerequisite for sustainable economic development of the countries in the context of financial globalization of markets and macroeconomic instability. However, the crisis in 2008 clearly showed weak ability of the banking system to withstand shocks, and ineffectiveness of the existing mechanisms of regulation and control of financial institutions. The need for public policy preventing liquidity shortages and mass bankruptcy became obvious. The problem is moral hazard, stimulated by possible government liquidity provision and monitoring of &quot;problem zones&quot;. Efficiency is also reduced by the imperfect mechanism of choosing bail-out candidates: key criteria based on gross quantitative indicators and weakly accounting for performance and network effects. It can lead to enormous pressure on small banks, some of which may be, for example, Core Company. Then pressure results may have negative consequences not only for direct clients but for a much larger number of citizens.</p><p>We propose ex ante bail-out decision mechanism designed to minimize both moral hazard effects and regulator&rsquo;s monitoring costs. The issue of omitted as bail-out candidates but potentially significant financial institutions is also taken in to account.</p>