Regulators dealing with banks with high non-performing loan levels need to adopt a “stick and carrot” policy, a working paper published by the Bank of Italy says.

In Optimally solving banks’ legacy problems, Anatoli Segura and Javier Suarez present a stylised model of how lenders interact with regulators.

In their model, banks have non-performing loans (NPLs), and there is a deposit guarantee scheme. Regulators intervene in the market by requiring banks to dispose of different levels of NPLs