Why Some Banks Recover and Others Don't

Most experts debating bail-in and bail-out strategies agree that banks should build capital and shrink balance sheets as the best way to avoid a collapse and rebuild after one. But researchers are suggesting a more personalized version of that recipe that makes the difference between life and death for struggling firms.

In a recent paper, Bank of Italy's Emilia Bonaccorsi di Patti and the University of Chicago's Anil Kashyap found that banks which successfully recover from sharp drops in profitability have something in common: They avoid throwing good money after bad by resolutely shutting off credit to their riskiest clients. Banks that increase risky lending in hopes of boosting profitability tend to lose the gamble and fail to recover. The general rule appears to be the same as in casino gambling: Losing is OK, but trying to win back the losses is truly dangerous.