Bank Resolution and Public Backstop in an Asymmetric Banking Union

Abstract

We characterize the optimal banking union with endogenous participation in a two-country economy in which domestic bank failures may be contemporaneous to sovereign crises, giving rise to risk-sharing motives to mutualize the funding of bailouts. Bank bail-ins create disruption costs that are private information of domestic authorities. We find that when country asymmetry is large, resolution policies are ex-post inefficient: They exhibit reduced contributions to the public backstop by the fiscally stronger country, lead to more bailouts and forbearance in early bank intervention in that country, and may render the weaker country a net contributor of funds within the union.

Keywords: Banking Union, Bail-In, Bailout, Public Backstop, Mechanism Design

JEL Classification: G01, G21, G28