Peer monitoring via loss mutualization

Francesco Palazzo

No 1088, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: After the 2008 financial crisis, the allocation of losses resulting from a bank bankruptcy has been one of the main policy issues. Several new regulatory provisions increased the burden of losses endured by the rest of the financial industry. For example, bank resolution schemes and mandatory clearing through Central Counterparties (CCPs) introduce mechanisms to share losses among surviving banks, with an emphasis on ensuring a sufficient loss absorption capacity. Without understating this relevant concern, this article suggests that a loss mutualization scheme may also foster market discipline by other banks (peers) if combined with an appropriate design of the relevant metrics used to allocate losses among surviving banks. The optimal design should impose higher contributions on banks with closer interlinkages with the defaulter. In this respect, the results highlight how the allocation of losses beyond the defaulter's initial contribution plays a considerable role on peer monitoring incentives.

Keywords: peer monitoring; default fund; resolution fund; clearinghouse; collateral (search for similar items in EconPapers)
JEL-codes: G23 G28 (search for similar items in EconPapers)
Date: 2016-10
New Economics Papers: this item is included in nep-net
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