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

  • 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 loss-bearing 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 self-place such securities.

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Author:Irene Mecatti, Tobias TrögerORCiDGND
Series (Serial Number):SAFE working paper (379)
Place of publication:Frankfurt am Main
Document Type:Working Paper
Year of Completion:2023
Year of first Publication:2023
Publishing Institution:Universitätsbibliothek Johann Christian Senckenberg
Release Date:2023/02/03
Edition:January 2023
Page Number:21
This paper has been written as a part of the research project “State aid to banks: the outlook following the Tercas case” supported by a grant from the Bank of Italy.
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / House of Finance (HoF)
Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Wissenschaftliche Zentren und koordinierte Programme / Sustainable Architecture for Finance in Europe (SAFE)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
JEL-Classification:G Financial Economics / G0 General / G01 Financial Crises (Updated!)
G Financial Economics / G1 General Financial Markets / G18 Government Policy and Regulation
G Financial Economics / G2 Financial Institutions and Services / G21 Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
G Financial Economics / G2 Financial Institutions and Services / G28 Government Policy and Regulation
K Law and Economics / K2 Regulation and Business Law / K22 Corporation and Securities Law
K Law and Economics / K2 Regulation and Business Law / K23 Regulated Industries and Administrative Law
Licence (German):License LogoDeutsches Urheberrecht