BACKGROUND: Mental health problems in older people are common and costly, posing multiple challenges for commissioners. Against this backdrop, a series of initiatives have sought to shift resources from institutional to community care in the belief that this will save money and concurs with user preferences. However, most of this work has focused on the use of care home beds and general hospital admissions, and relatively little attention has been given to reducing the use of mental health inpatient beds, despite their very high cost. METHODS: The study employed a 'Balance of Care approach' in three areas of North-West England. This long-standing strategic planning framework identifies people whose needs can be met in more than one setting, and compares the costs and consequences of the possible alternatives in a simulation modelling exercise. Information was collected about a six-month cohort of admissions in 2010/11 (n = 216). The sample was divided into groups of people with similar needs for care, and vignettes were formulated to represent the most prevalent groups. A range of key staff judged the appropriateness of these admissions and suggested alternative care for those considered least appropriate for hospital. A public sector costing approach was used to compare the estimated costs of the recommended care with that people currently receive. RESULTS: The findings suggest that more than a sixth of old age psychiatry inpatient admissions could be more appropriately supported in other settings if enhanced community services were available. Such restructuring could involve the provision of intensive support from Care Home Outreach and Community Mental Health Teams, rather than the development of crisis intervention and home treatment teams as currently advocated. Estimated savings were considerable, suggesting local agencies might release up to £1,300,000 per annum. No obvious trade-off between health and social care costs was predicted. CONCLUSIONS: There is considerable potential to change the mix of institutional and community services provided for older people with mental health problems. The conclusions would be strengthened by further studies and the incorporation of evidence about relative outcomes. However, the utility of the approach in challenging established patterns of resource allocation and building local ownership for change is apparent.