Working Paper: CEPR ID: DP10065
Authors: Emilios Avgouleas; Charles A. Goodhart
Abstract: Many of the world?s developed economies have introduced, or are planning to introduce, bank bail-in regimes. Both the planned EU resolution regime and the European Stability Mechanism Treaty involve the participation of bank creditors in bearing the costs of bank recapitalization via the bail-in process as one of the (main) mechanisms for restoring a failing bank to health. There is a long list of actual or hypothetical advantages attached to bail-in centred bank recapitalizations. Most importantly the bail-in tool involves replacing the implicit public guarantee, on which fractional reserve banking has operated, with a system of private penalties. The bail-in tool may, indeed, be much superior in the case of idiosyncratic failure. Nonetheless, there is need for a closer examination of the bail-in process, if it is to become a successful substitute to the unpopular bailout approach. This paper discusses some of its key potential shortcomings. It explains why bail-in regimes will fail to eradicate the need for an injection of public funds where there is a threat of systemic collapse, because a number of banks have simultaneously entered into difficulties, or in the event of the failure of a large complex cross-border bank, except in those cases where failure was clearly idiosyncratic.
Keywords: bailin; bank recapitalisation; bank regulation; creditor flight; moral hazard
JEL Codes: G18; G28; K20; L51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| bail-ins are intended to replace public bailouts (G28) | reduce moral hazard (G52) |
| bail-ins are intended to replace public bailouts (G28) | enhance market discipline (G18) |
| systemic failure (P11) | necessitate public fund injections (H81) |
| bail-ins (G28) | creditor flight (G33) |
| bail-ins (G28) | increased funding costs (G32) |
| weaker banks (G21) | diminish ability to raise funds (H69) |
| diminish ability to raise funds (H69) | further instability (Y50) |