Containing Runs on Solvent Banks: Prioritizing Recovery over Resolution

Edoardo Martino () and Enrico Perotti ()
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Edoardo Martino: YPFS, Yale School of Management, https://elischolar.library.yale.edu/journal-of-financial-crises/
Enrico Perotti: YPFS, Yale School of Management, https://elischolar.library.yale.edu/journal-of-financial-crises/

Journal of Financial Crises, 2025, vol. 7, issue 1, 1-30

Abstract: The sudden banking defaults in the spring of 2023 proved current prudential norms insufficient to prevent bank distress. Capital and liquidity norms need to be adjusted. The experience also shows how a lack of credible supervisory tools led to forbearance and finally chaotic public bailouts. An intervention gap arises when viable but undercapitalized banks are at the mercy of runs. Once outflows start to escalate, all that is left is to prepare for resolution and assign losses. We call for new Pillar II - i.e. activated by the supervisor - stabilizing measures, as contingent capital and liquidity tools. A timely recapitalization option requires stronger supervisory powers to activate a timely going-concern recapitalization, such as by equity conversion of additional Tier 1 contingent convertible debt. One contingent liquidity measure is the automatic activation of redemption charges upon large outflows of uninsured deposits. The goal is to interrupt any self-fulfilling expectation of further outflows. The measure mirrors new US Securities and Exchange Commission norms created for institutional money market funds, the natural benchmark for uninsured corporate deposits. The combination creates a framework for credible interim intervention and a chance to steer solvent banks toward recovery early on rather than settling for forbearance and increasing the probability of resolution and bailouts.

Keywords: bank resolution; bank recovery; contingent capital; redemption charges (search for similar items in EconPapers)
JEL-codes: G01 G28 (search for similar items in EconPapers)
Date: 2025
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