51 Pages Posted: 30 Nov 2013 Last revised: 20 Aug 2014
Date Written: August 20, 2014
The project of creating a Banking Union is designed to overcome the fatal link between sovereigns and their banks in the Eurozone. As part of this project, political agreement for a common supervision framework and a common resolution scheme has been reached with difficulty. However, the resolution framework is weak, underfunded and exhibits some serious flaws. Further, Member States’ disagreements appear to rule out a federalized deposit insurance scheme, commonly regarded as the necessary third pillar of a successful Banking Union. This paper argues for an organizational and capital structure substitute for these two shortcomings that can minimize the systemic distress costs of the failure of a large financial institution. We borrow from the approach the Federal Deposit Insurance Corporation (FDIC) has devised in the implementation of the “Orderly Liquidation Authority” under the Dodd Frank Act. The FDIC’s experience teaches us three important lessons: first, systemically important institutions need to have in their liability structure sufficient unsecured (or otherwise subordinated) term debt so that in the event of bank failure, the conversion of debt into equity will be sufficient to absorb asset losses without impairing deposits and other short term credit; second, the organizational structure of the financial institution needs to permit such a debt conversion without putting core financial constituents through a bankruptcy, and third, a federal funding mechanism deployable at the discretion of the resolution authority must be available to supply liquidity to a reorganizing bank. On these conditions, a viable and realistic Banking Union would be within reach — and the resolution of global financial institutions would be greatly facilitated, not least in a transatlantic perspective.
Keywords: banking resolution, banking union, deposit guarantee, bail-in, centralization, political economy
JEL Classification: E44, F34, F36, G15, G21, G30, K20, K22
Suggested Citation: Suggested Citation
Gordon, Jeffrey N. and Ringe, Wolf-Georg, Bank Resolution in the European Banking Union: A Transatlantic Perspective on What it Would Take (August 20, 2014). Columbia Law Review, Forthcoming; Columbia Law and Economics Working Paper No. 465; Oxford Legal Studies Research Paper No. 18/2014. Available at SSRN: https://ssrn.com/abstract=2361347 or http://dx.doi.org/10.2139/ssrn.2361347