What is the joint impact of different resolution regimes and capital requirements on the optimal liability structure of a bank holding insured deposits and issuing non-bail-inable debt and bail-inable Tier1-capital debt? We address this novel question and find that: (1) a credible bail-in resolution regime rules out extreme leverage and creates value by postponing default; (2) a positive probability of bail-out destroys credibility with dramatic effects on financial risk-taking, to the point of reversing the classical positive link between optimal leverage and growth prospects; and (3) a strict enforcement of the Basel III CET1 capital requirement strongly mitigates the impact of a non-credible resolution regime.
Leanza, L., Sbuelz, A., Tarelli, A., Bail-in vs bail-out: Bank resolution and liability structure, <<INTERNATIONAL REVIEW OF FINANCIAL ANALYSIS>>, 2021; 73 (January 2021): N/A-N/A. [doi:10.1016/j.irfa.2020.101642] [http://hdl.handle.net/10807/165385]
Bail-in vs bail-out: Bank resolution and liability structure
Leanza, Luca;Sbuelz, Alessandro;Tarelli, Andrea
2021
Abstract
What is the joint impact of different resolution regimes and capital requirements on the optimal liability structure of a bank holding insured deposits and issuing non-bail-inable debt and bail-inable Tier1-capital debt? We address this novel question and find that: (1) a credible bail-in resolution regime rules out extreme leverage and creates value by postponing default; (2) a positive probability of bail-out destroys credibility with dramatic effects on financial risk-taking, to the point of reversing the classical positive link between optimal leverage and growth prospects; and (3) a strict enforcement of the Basel III CET1 capital requirement strongly mitigates the impact of a non-credible resolution regime.
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