The Dark Side of Bank Resolution: Counterparty Risk through Bail-in

51 Pages Posted: 11 Jan 2019 Last revised: 4 Mar 2019

See all articles by Wolf-Georg Ringe

Wolf-Georg Ringe

University of Hamburg - Institute of Law & Economics; University of Oxford - Faculty of Law; European Corporate Governance Institute (ECGI)

Jatine Patel

University of Hamburg - Institute of Law and Economics; University of Oxford

Date Written: March 1, 2019

Abstract

The introduction of bail-in resolution powers to impose the costs of a large bank’s failure on its creditors (rather than on the taxpayer) is the most intriguing initiative of the post-financial crisis regulatory framework. However, a fundamental conundrum remains in the legal regime: it is unclear who should hold bank capital that is subject to bail-in.
This paper argues that such regulatory agnosticism as to the ideal counterparties of bail-in-able debt facilitates the subversion of the new bail-in tool. This includes inducing banking capital investors to counterproductively choose outcomes that further systemic risk.
Using a difference-in-differences methodology, we provide evidence from the introduction of bail-in powers at the Eurozone level, showing that the introduction of bail-in powers went hand in hand with a growing interconnectedness of European banks. This confirms that counterparties matter fundamentally to bail-in, in a way that might be counterproductive for the objectives of bail-in, and that this counterproductivity results within the current regulatory framework’s prescriptive paradigm.
We then discuss the challenges of regulating individual entities, within the financial system ‘commons’, to optimise banking capital counterparties. In particular, we develop Coasian, as opposed to prescriptive, principles that are likely to improve the current framework by facilitate learning about and adjusting to systemic risk. This article builds upon the literature by providing an analysis of the interaction between banking capital counterparties and bail-in; identifying a significant gap in the regulatory framework; and explaining why Coasian regulatory measures are necessary.

Keywords: bail-in, bank resolution, interconnectedness, systemic risk, Eurozone

JEL Classification: G21,G28,G33

Suggested Citation

Ringe, Wolf-Georg and Patel, Jatine, The Dark Side of Bank Resolution: Counterparty Risk through Bail-in (March 1, 2019). European Banking Institute Working Paper Series 2019 – no. 31; Oxford Legal Studies Research Paper. Available at SSRN: https://ssrn.com/abstract=3314103 or http://dx.doi.org/10.2139/ssrn.3314103

Wolf-Georg Ringe (Contact Author)

University of Hamburg - Institute of Law & Economics ( email )

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Hamburg, 20148
Germany
+49 40 42838 7787 (Phone)
+49 40 42838 6794 (Fax)

HOME PAGE: http://www.ile-hamburg.de

University of Oxford - Faculty of Law

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Oxford, OX1 3UL
United Kingdom

HOME PAGE: http://www.law.ox.ac.uk/people/wolf-georg-ringe

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://ecgi.global/users/wolf-georg-ringe

Jatine Patel

University of Hamburg - Institute of Law and Economics ( email )

Johnsallee 35
Hamburg, 20148
Germany

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

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