Bank equity stakes in borrowing firms and financial distress

We derive the optimal financial claim for a bank when the borrowing firm's uninformed stake-holders depend on the bank: to establish whether tbe firm is distressed and whether concessions by stakeholders are necessary. The bank's financial claim is designed to ensure that it cannot collude with a healthy firm's owners to seek unnecessary concessions or to collude with a distressed firm's owners to claim that the firm is healthy. To prove that a request for concessions has not come from a healthy firm/bank coalition, the bank must hold either a very small or a very large equity stake when the firm enters distress. To prove that a distressed firm and the bank: have not colluded to claim that the firm is healthy, the bank may need to hold equity under routine financial conditions.