Special Resolution Regimes for Banking Institutions: Objectives and Limitations

Abstract

In the present environment of weak banks and shaky state finances, the introduction of so-called Special Resolution Regimes (SRRs) for failed banking institutions has developed into a global and European policy priority. This paper responds to certain claims made in relation to the proper objectives and mode of operation of SRRs, with particular reference to a recent paper by Gustav Sjöberg. SRRs are supposed to set out effective tools for handling the failure of systemically important banks in a manner that preserves systemic stability and secures the continuous provision of the key functions of the financial system; at the same time, they incorporate elements of strict enforcement, in order to preserve market discipline and curtail moral hazard. Many policy-makers and scholars assume that an SRR with appropriate legislative objectives and strong intervention tools can of itself reconcile the aforementioned purposes.

However, any SRR which enables the continuation and restructuring of insolvent banks’ operations with outside financial support, if this appears justified for systemic reasons, and/or provides protection to certain stakeholders (typically, depositors), entails by definition a relaxation of market discipline. Due to the inclusion in the statutory framework of strong elements of discretion, such a system will always be amenable ex post to negotiated enforcement and strategic behaviour on the part of bank stakeholders, who demand forbearance. Thus, a well-designed SRR can at most establish a structured and robust decisional framework, reducing the ability of the latter to game the system. But it cannot act as an effective ex ante governance tool.