What Makes Large Bank Failures so Messy and What to Do About it?

41 Pages Posted: 10 Apr 2014

See all articles by James McAndrews

James McAndrews

Wharton Financial Institutions Center

Donald P. Morgan

Federal Reserve Bank of New York

João A. C. Santos

Federal Reserve Bank of New York

Tanju Yorulmazer

University of Amsterdam - Faculty of Economics and Business (FEB)

Date Written: March 31, 2014

Abstract

We argue that the defining feature of large and complex banks that makes their failures messy is their reliance on runnable financial liabilities that confer liquidity or money-like services that may be impaired or destroyed in bankruptcy. To make large bank failures more orderly, we advocate that systemically important bank holding companies be required to issue “bail-inable” long-term debt that converts to equity in resolution. This reassures holders of uninsured liabilities that their claims will be honored in resolution, making them less likely to run. In a novel finding, we show that bail-inable debt and equity are not perfect substitutes in terms of stemming bank runs. Finally, we argue that the long-term debt requirement should be increasing in the amount of uninsured financial liabilities the bank has issued. This has the advantage of tying the requirement to the sources of messy failures, and it tends to internalize the externalities associated with issuance of uninsured financial liabilities.

JEL Classification: G20, G28, G01

Suggested Citation

McAndrews, James and Morgan, Donald P. and Santos, João A. C. and Yorulmazer, Tanju, What Makes Large Bank Failures so Messy and What to Do About it? (March 31, 2014). Economic Policy Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2422440

James McAndrews

Wharton Financial Institutions Center ( email )

2306 Steinberg Hall-Dietrich Hall
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Philadelphia, PA 19104
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Donald P. Morgan (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
Research Department
New York, NY 10045
United States
212-720-6573 (Phone)

João A. C. Santos

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-5583 (Phone)
212-720-8363 (Fax)

HOME PAGE: HTTP://WWW.NEWYORKFED.ORG/RMAGHOME/ECONOMIST/SANTOS/CONTACT.HTML

Tanju Yorulmazer

University of Amsterdam - Faculty of Economics and Business (FEB) ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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