Fluctuating Bail-in Expectations and Effects on Market Discipline, Risk-taking and Cost of Capital

66 Pages Posted: 20 Mar 2017 Last revised: 15 Dec 2021

Date Written: January 8, 2019

Abstract

Through the compulsory participation of junior investors in bearing losses of their failing bank, the bail-in attempts to limit bail-outs’ side-effects in terms of market discipline, too-big-to-fail, bank-sovereign nexus and risk-taking. This paper assesses the consequences of bail-in expectations along these dimensions ensuring – through a bond pricing study – that bail-in expectations are not confounded by other factors. Using hand-collected details of EU bail-in events, I study both positive and negative exogenous shocks to bail-in expectations, offering three sets of findings. First, bail-in events can reinforce (or weaken) bail-in expectations, as shown by Khwaja-Mian tests that are validated by placebo analyses. Second, bail-in expectations promote market discipline, and mitigate too-big-to-fail and bank-sovereign nexus. Third, bail-in effects on bank resilience appear mixed. While it incentivises banks to reduce risk-taking (e.g., increasing risk-weighted equity by a third of Basel III requirement), it also remarkably exacerbates total funding costs through an increase in equity cost (partially off-set by a debt cost reduction).

Keywords: bail-in, bail-out, bailinable, bonds, experiment, event

JEL Classification: G2, G33

Suggested Citation

Giuliana, Raffaele, Fluctuating Bail-in Expectations and Effects on Market Discipline, Risk-taking and Cost of Capital (January 8, 2019). ESRB Working Paper Series No. Forthcoming, Available at SSRN: https://ssrn.com/abstract=2935259 or http://dx.doi.org/10.2139/ssrn.2935259

Raffaele Giuliana (Contact Author)

Central Bank of Ireland ( email )

P.O. Box 559
Dame Street
Dublin, 2
Ireland

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