Sovereign Bailouts and Senior Loans
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Institutional lending in crisis is evaluated from a theoretical point of view. First, the share of senior loans in new loans is irrelevant under a given probability distribution of the country’s resources. Second, seniority may partially alleviate the inefficiency of debt contracts when the distribution of resources is endogenous to the country’s physical
investment and effort toward success. Third, with multiple lending rate equilibria, institutional lending may induce a switch to a lower private loan rate if it can be done in a sufficiently large amount. Fourth, conditions are analyzed under which debt forgiveness is efficient under a financial shock.
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The views herein are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank of the governments they represent.