Who should hold bail-inable debt and how can regulators police holding restrictions effectively?

Irene Mecatti and Tobias Tröger

No 379, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: This paper analyses the demand-side prerequisites for the efficient application of the bail-in tool in bank resolution, scrutinises whether the European bank crisis management and deposit insurance (CMDI) framework is apt to establish them, and proposes amendments to remedy identified shortcomings. The first applications of the new European CMDI framework, particularly in Italy, have shown that a bail-in of debt holders is especially problematic if they are households or other types of retail investors. Such debt holders may be unable to bear losses, and the social implications of bailing them in may create incentives for decision makers to refrain from involving them in bank resolution. In turn, however, if investors can expect resolution authorities (RAs) to behave inconsistently over time and bail-out bank capital and debt holders despite earlier vows to involve them in bank rescues, the pricing and monitoring incentives that the crisis management framework seeks to invigorate would vanish. As a result, market discipline would be suboptimal and moral hazard would persist. Therefore, the policy objectives of the CMDI framework will only be achieved if critical bail-in capital is not held by retail investors without sufficient lossbearing capacity. Currently, neither the CMDI framework nor capital market regulation suffice to assure that this precondition is met. Therefore, some amendments are necessary. In particular, debt instruments that are most likely to absorb losses in resolution should have a high minimum denomination and banks should not be allowed to selfplace such securities.

JEL-codes: G01 G18 G21 G28 K22 K23 (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-ban and nep-law
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Citations: View citations in EconPapers (1)

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