Controlling Moral Hazard in Bank Resolutions: Comparative Policies & Considerations in System Design

32 Pages Posted: 23 Apr 2008

See all articles by Michael Krimminger

Michael Krimminger

Cleary Gottlieb Steen & Hamilton LLP

Date Written: July 2006

Abstract

This paper reviews the key legal and policy measures designed to limit moral hazard in bank insolvency systems and compares and explores how existing national insolvency systems have implemented these principles. While many legal systems include prohibitions or limitations on the use of public money to bailout a failing bank, many systems do not provide effective alternatives to a bailout. As a consequence, in crises policymakers often have little choice but to resort to broad public guarantees that maximize the disincentives to market discipline. The history of recent bank failures around the world shows that by itself a simple prohibition on public funding or a limitation to least, lesser or liquidation costs does not work. The paper argues that for cost controls to be effective regulatory authorities must have real alternatives to a bailout or liquidation. This requires balancing cost limitations or bans on public bailouts with a flexible system of bank resolution that allows continuation of key banking functions despite the collapse of the bank.

Keywords: prompt corrective action, banking resolutions, insolvency, moral hazard

JEL Classification: E5, E6, G18, G21

Suggested Citation

Krimminger, Michael, Controlling Moral Hazard in Bank Resolutions: Comparative Policies & Considerations in System Design (July 2006). Available at SSRN: https://ssrn.com/abstract=1123224 or http://dx.doi.org/10.2139/ssrn.1123224

Michael Krimminger (Contact Author)

Cleary Gottlieb Steen & Hamilton LLP ( email )

One Liberty Plaza
New York, NY 10006
United States

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