Burden Sharing in a Banking Crisis in Europe

Abstract

Pan-European banks are starting to emerge, while arrangements for financial supervision and stability are still nationally rooted. This raises the issue who should bear the burden of any proposed recapitalisation should failures occur in a large cross-border bank. A recapitalisation is efficient if the social benefits (preserving systemic stability) exceed the cost of recapitalisation. Using the multi-country model of Freixas (2003), it is shown that ex post negotiations on burden sharing lead to an underprovision of recapitalisations.

We explore different ex ante burden sharing mechanisms. The first is a general scheme financed from the seignioriage of participating central banks (generic burden sharing). The second relates the burden to the location of the assets of the bank to be recapitalised (specific burden sharing). As a country's benefits and that country's contribution to the costs are better aligned in the specific scheme, the latter is better able to overcome the co-ordination failure.

Keywords: Banks, Financial Stability, Public Finance, Recapitalisation, Lender of Last Resort

JEL Classification: E58, E60, G21, G28