Has bail-in increased market discipline? An empirical investigation of European banks’ credit spreads

Ryan Lindstrom (ryan.lindstrom@bankofengland.co.uk) and Matthew Osborne
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Ryan Lindstrom: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH

No 887, Bank of England working papers from Bank of England

Abstract: Following the banking sector stress events of 2008–09 and 2011–12, a new framework for resolving failing banks has been implemented in the European Union which aims to facilitate authorities imposing losses on private creditors. The new framework implements global standards requiring banks to maintain a minimum quantum of loss-absorbing (or ‘bail-in’) bonds. Using data on the credit spreads on large European banks’ bonds between 2010 and 2019, we provide evidence that the risk sensitivity of banks’ credit spreads has increased since the reforms, and that the level and risk sensitivity of spreads on senior bail-in bonds are higher than those of comparable non-bail-in bonds. These findings support the hypothesis that the reforms have increased investors’ perception of the likelihood that they will be bailed in. These results hold for both UK and euro-area banks, though they are somewhat weaker for periphery European banks. We show that the degree of progress a bank has made in issuing bail-in bonds is positively related to the level and risk sensitivity of such bonds. We show that the higher level and risk sensitivity of spreads on bail-in bonds are largely invariant to whether bail-in bonds are contractually subordinated (ie issued as non-preferred senior) or structurally subordinated (ie issued from the holding company), and the effects are also unaffected by whether or not a bank is classified as a global systemically important bank (G-SIB). Finally, we show that the results are robust to changes in the strategy or risk profile of individual banks, via the inclusion of time-varying bank-specific effects.

Keywords: Banks; bank resolution; financial stability; bail-in (search for similar items in EconPapers)
JEL-codes: G21 G28 G33 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2020-11-06
New Economics Papers: this item is included in nep-ban and nep-eec
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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