Fiscal Burden Sharing in Cross-Border Banking Crises

Abstract

This paper focuses on the recapitalisation of failing banks. A recapitalisation is efficient if the social benefits (preserving systemic stability) exceed the cost of recapitalisation. In a national setting, the implementation of an optimal policy is relatively straightforward. But in a cross-border setting, one is confronted with possible co-ordination failure. Using a multi-country model, it is shown that ex post negotiations on burden sharing lead to an underprovision of recapitalisations. Next, we explore different ex ante burden sharing mechanisms. The first is a general scheme financed collectively by the participating countries (generic burden sharing). The second relates the burden to the location of the assets of the bank to be recapitalised (specific burden sharing). The working of the two mechanisms is calibrated with data on large cross-border banks in Europe. As the costs and benefits 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

JEL Classification: E58, E60, G21, G28