Bail-in and Bank Funding Costs

Abstract

We empirically evaluate the impact of the new resolution policy, the so-called Bank Recovery and Resolution Directive (BRRD) enacted in 2016, on the cost of funding for EU banks. We first measure the change in the spreads of credit default swaps on subordinated and senior bonds issued by EU banks around the period when the policy became effective and provide evidence of a greater increase in the risk premia of more junior bail-in-able bonds than for senior bonds. We then investigate the reasons for the different intensities by which this policy has affected the banks in our sample. We uncover specific characteristics of banks and macroeconomic factors to explain this heterogeneity. Banks with more problematic loans, that are less capitalized, and that are headquartered in countries with a higher risk premium on sovereign debt have experienced a greater rise in the cost of their funds; conversely, larger banks with a greater proportion of domestic over total subsidiaries were less affected. Moreover, we show that the low-interest-rate environment has increased the riskiness of all the banks in our sample. Overall, our paper provides evidence that market discipline has been reinforced by the adoption of the BRRD.

Keywords: Bank resolution; Credit Default Swaps; Market discipline

JEL Classification: G28; G21; G14