During the recent financial crisis, resolution mechanisms proved to be insufficient to wind down systemically important financial institutions. Especially the bankruptcy of Lehman Brothers led to severe macroeconomic instability. Afterwards, national and supranational authorities implemented new regulations for preventing and managing bank failures, among them the Single Resolution Mechanism (SRM) in the European Banking Union.
The failure of Banco Popular in June 2017 put the SRM to the first test. As the resolution mechanism apparently worked smoothly, and did not contaminate other banks or even the non-banking industry, the question arises whether the resolution mechanism has consequently become more credible for bank investors. By analyzing market reactions to the Banco Popular bail-in, the author primarily aims to answer this question. Hypothetically, if investors perceive the bail-in as a credible commitment by the Single Resolution Board, the implicit insurance should cease. For this reason, investors would demand higher, risk-reflecting interest rates, impairing the bank’s profitability. Therefore, in the case that this is the dominant effect, a bank’s share price should fall.
In this book:
- Single Resolution Mechanism;
- European Banking Union;
- financial industry regulations;
- bail-in and bail-out;
- too big to fail banks;
- Banco Popular
Table of Contents
1 Introduction
2 To Bail-in or Not to Bail-in
2.1 The General Approach
2.2 The Regulator’s Decision Process
2.3 Effect of too-big-to-fail
2.4 Addressing the Problem
3 Event Study
3.1 Previous Studies
3.2 Context
3.3 Hypotheses
3.4 Methodology
3.5 Robustness Testing
3.6 Interpretation of Results
3.7 Shortcomings and Further Research
4 Conclusion
Research Objectives and Themes
This thesis examines whether the Single Resolution Mechanism (SRM) has gained credibility among European bank investors following the first successful application of its resolution tools in the Banco Popular bail-in. By conducting an event study on European banking stock returns, the research investigates whether market participants perceive the bail-in as a credible commitment to resolve distressed banks without taxpayer intervention, thereby testing the validity of the too-big-to-fail hypothesis.
- Regulatory decision processes regarding bank bail-outs versus bail-ins.
- Theoretical implications of the too-big-to-fail (TBTF) problem and moral hazard.
- Empirical analysis of market reactions to the Banco Popular resolution.
- Evaluation of bank characteristics such as business models and systemic importance on stock returns.
Excerpt from the Book
3.1 Previous Studies
There are several empirical analyses using regulatory event studies to estimate the effects of bail-out expectations: Schäfer et al. (2015) analyze the reaction of four major regulatory reforms on stock return and credit default swaps (CDS). They found that financial markets expected higher default probabilities and lower profitability, especially for systemic institutions, after the introduction of the structural reforms. Ignatovski and Korte (2014) explore the effect of the introduction of the OLA on a banks’ risk level. The OLA expanded the FDIC’s authority to liquidate financial institutions in the U.S. and therefore reduced the bail-out expectations and subsequent risk level for affected banks according to the authors’ findings. However, they demonstrate that this effect is not apparent for large, systemic banks which remain TBTF.
In contrast to these works, I will not analyze the introduction or announcement of a regulatory reform, but will consider its execution. As the regulator faces a credibility problem, the effect of introduced new regulations is mitigated for TBTF banks. However, an actual and successful resolution, could have the power to mitigate the bank’s bail-out expectations. Probably most closely related to this thought and my investigation is the work of Schäfer et al. (2016). The authors analyzed CDS spreads and abnormal stock returns after five bail-ins in the EU and after the implementation of the SRM. All bail-ins occurred before the SRM came into force. Therefore, the banks were resolved by the national authorities and not by the SRB. Their main conclusion is that actions have more power than words as markets reacted more strongly to actual bail-ins than to the implementation of new bail-in rules. Furthermore, they first show that banks from GIIPS2 countries reacted more strongly than banks from non-GIIPS countries. This suggests that a bail-in is more likely in a country with local fiscal ability. Secondly, they prove that a large bail-in basis and a strong political spillover of the respective resolution further increase bail-in expectations.
Summary of Chapters
1 Introduction: Provides the context of financial crisis regulation and sets the research objective regarding the credibility of the Single Resolution Mechanism.
2 To Bail-in or Not to Bail-in: Elaborates on the regulator's decision-making process, the moral hazard problem caused by too-big-to-fail expectations, and potential policy solutions.
3 Event Study: Details the empirical methodology and analysis of market reactions to the Banco Popular bail-in, including robustness tests and interpretation of findings.
4 Conclusion: Synthesizes the empirical findings and discusses the implications for the future credibility of the SRM in the European banking sector.
Keywords
Bail-in, Single Resolution Mechanism, SRM, Banco Popular, too-big-to-fail, TBTF, moral hazard, market discipline, event study, cumulative abnormal return, CAR, bank regulation, financial stability, systemic risk, bank resolution.
Frequently Asked Questions
What is the core focus of this research?
The research investigates the credibility of the Single Resolution Mechanism (SRM) by analyzing how stock markets reacted to the first major bail-in of a European bank, Banco Popular.
What are the primary themes discussed?
Key themes include the trade-offs in bank resolution policies, the moral hazard created by implicit government guarantees, and the influence of systemic importance on market perceptions of bank risk.
What is the main research question?
The central question is whether the Single Resolution Mechanism has become more credible for European bank investors after the successfully executed bail-in of Banco Popular in 2017.
Which methodology is applied to answer the research question?
The author employs a quantitative event study methodology to calculate cumulative abnormal returns (CAR) for 45 European banks surrounding the event date.
What is covered in the main body of the thesis?
The main body covers the regulator's trade-offs (bail-in vs. bail-out), literature reviews on TBTF, detailed empirical analysis of market reaction, and robustness tests of the results.
Which keywords define the work?
The work is defined by terms such as bail-in, SRM, moral hazard, TBTF, bank resolution, and cumulative abnormal returns.
Why was the Banco Popular bail-in chosen as the specific case study?
It represents the first application of the SRM tools, providing a unique "natural experiment" to see if regulators could credibly resolve a bank without taxpayer funds.
What conclusion does the author reach regarding the SRM's credibility?
The author concludes that while the resolution was perceived positively by markets—likely due to the "stability explanation" and relief that contagion was avoided—it is difficult to unambiguously state that the SRM's credibility is fully established, especially for larger, more systemic banks.
- Citar trabajo
- Mark Feiler (Autor), 2017, On the Credibility of Bail-ins. Has the Single Resolution Mechanism become more credible for European Banks after the Banco Popular Bail-in?, Múnich, GRIN Verlag, https://www.grin.com/document/379530
