Banking Resolution: Lessons from the Crisis

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Prof. Xavier Freixas (UPF and Barcelona GSE)

Keynote lecture for Norges Bank's Financial Stability Conference, "Government intervention and moral hazard in the financial sector" on September 2, 2010 in Oslo, Norway.

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Banking Resolution: Lessons from the Crisis

  1. 1. Banking Resolution: Lessons from the Crisis Introduction The banks’ Banking Resolution: Lessons from the Crisis resolution problem Bankruptcy law Xavier Freixas Comparison Universitat Pompeu Fabra Resolution in a systemic crisis The ex ante design Cross-Border regulation Conclusion
  2. 2. Motivation Banking Resolution: Lessons from the Crisis Introduction The banks’ The recent crisis resolution problem Some precedents Bankruptcy law S&L crisis Comparison Scandinavian crisis Resolution in a systemic crisis South Asian crisis The ex ante design Cross-Border regulation Conclusion
  3. 3. Cost bene…t at the margin Banking Resolution: Lessons from the Crisis Π =Shareholders’pro…ts Introduction S =Supervision, The banks’ resolution K =Capital requirements and problem D =Deposit insurance Bankruptcy law max αΠ + (1 α)pCost Comparison Resolution in a Π = Π(S, K , D ) systemic crisis The ex ante p = p (S, K , D ) design Cost = Cost (S, K , D ) Cross-Border regulation Conclusion
  4. 4. What intervention? Banking Resolution: Regulatory objectives Lessons from the Crisis The time framework of banks’resolution: a three stage game Introduction The banks’ resolution problem Bankruptcy law Comparison Resolution in a systemic crisis The ex ante design Cross-Border regulation Conclusion
  5. 5. A long list of mechanisms Resolution mechanisms Banking Resolution: Lessons from the Crisis Assets or liabilities? Open bank …nance Introduction Assisted merger and acquisition (Purchase and modi…ed The banks’ assumption) resolution problem Asset Guarantees Bankruptcy law Liability Guarantees Comparison Subsidized Debt Buybacks Resolution in a Good bank / bad bank separation systemic crisis Debt Equity swaps The ex ante design Capital Insurance (Kashyap, Rajan and Stein) Cross-Border CDS triggered equity issue (Hart and Zingales) regulation Recapitalization by Issuing Preferred Stock Conclusion Recapitalization, Nationalization, Bridge bank
  6. 6. What’ di¤erent about banks? s Banking Resolution: Debtholders, maturity and renegotiation Lessons from the Crisis Equitable insolvency vs. balance sheet insolvency Lex Specialis vs. lex generalis Introduction Characteristics of a general bankruptcy The banks’ resolution code: problem Fair treatment Bankruptcy law Maximizing value to creditors Comparison Banks speci…c crises Resolution in a systemic crisis Speedy The ex ante Renegotiation free, design Legal certainty Cross-Border regulation Providing liquidity to creditors Conclusion Informationally feasible Illustrations: the US Prompt corrective action and the EU proposal
  7. 7. Ex post comparison of alternative schemes Banking Resolution: Lessons from the Crisis Introduction The banks’ Comparing the alternative resolution schemes for a distressed resolution problem bank Bankruptcy Welfare maximization vs. Cost minimization law Lender of last resort …nancing Comparison Optimal structure of funding Resolution in a systemic crisis Optimal timing of the intervention The ex ante design Cross-Border regulation Conclusion
  8. 8. The speci…cs of a systemic crisis Banking Resolution: Lessons from the Crisis Introduction The banks’ resolution problem Why is it di¤erent? Contagion Bankruptcy Fostering a favourable macroeconomic environment law Limiting Contagion Comparison Implication: a systemic risk board is required Resolution in a systemic crisis The ex ante design Cross-Border regulation Conclusion
  9. 9. Banking system resiliance Banking Resolution: Lessons from the Crisis Characteristics of an e¢ cient restructuring system Introduction The banks’ Comparing alternative contingent mechanisms resolution problem Impact on incentives and corporate governance Bankruptcy law Limits in the design of a bank restructuring system. Comparison 1 Commitment vs. non-commitment or rules versus discretion Resolution in a 2 The legal framework systemic crisis 3 The regulators’objective function The ex ante design 4 Multiple domestic regulators Cross-Border 5 Transparency versus secrecy regulation Conclusion
  10. 10. International cooperation and competition among supervisory agencies Banking Resolution: Lessons from the Crisis Hardy and Nieto 2008 Introduction S =Supervision, The banks’ resolution K =Capital requirements and problem D =Deposit insurance Bankruptcy law max αΠ + (1 α)pCost Comparison Resolution in a Π = Π(S1 , S2, D1 , D2 ) systemic crisis The ex ante p = p (S1 , S2, D1 , D2 ) design Cost = Cost (S1 , S2, D1 , D2 ) Cross-Border regulation Conclusion
  11. 11. Cross-Border Resolution Banking Resolution: Lessons from the Crisis Introduction The banks’ resolution problem Universality vs. Territoriality Bankruptcy law Branches vs. Subsidiaries Comparison The Financial Trilemma Resolution in a systemic crisis The ex ante design Cross-Border regulation Conclusion
  12. 12. Europe at a cross-road Banking Resolution: Lessons from the Crisis Introduction The banks’ resolution problem the European banking structure Bankruptcy law Lessons from the Icelandic crisis Comparison Resolution in a systemic crisis The ex ante design Cross-Border regulation Conclusion
  13. 13. New proposals Banking Resolution: Lessons from the Crisis Macro-prudential policy Introduction Basel III The banks’ resolution Tax the banks problem Bankruptcy Increased transparency law Comparison Creation of new institutions Resolution in a Liquidity regulation systemic crisis The ex ante Living wills design Incentive banks to be structured as holding companies Cross-Border regulation that allow for partial merger and liquidations Conclusion
  14. 14. To conclude Banking Resolution: Lessons from the Crisis Introduction What is better regulation? The banks’ Right incentives resolution problem The e¢ cient regulatory reform should go to the source of the Bankruptcy law problem: design the right legal environemnt (bankruptcy rules, Comparison specialized agencies, corporate governance,...) Resolution in a Failing to address these issues either and resort to capital systemic crisis increases combined with generalized bail-outs will lead to an The ex ante design ine¢ cient banking industry. Cross-Border regulation Conclusion

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