Towards an optimal composition of bail-inable debtholders?

Abstract

The core insight of the new EU framework for bank resolution is to allocate losses to bank's insiders (bail-inable creditors). This affects both financial stability and the corporate governance of banks. The current academic debate on bank resolution overlooks the relevance of identifying the investors in bail-inable securities (ie who is going to bear losses) and the role of counterparty risk. This article identifies the investors that are better suited to hold those instruments and highlights the trade-offs between the corporate governance role and the threat to financial stability posed by different investors. The article demonstrates that the composition of bail-inable debtholders matters and shows–empirically and theoretically–a transition towards a desirable composition of holders; although a considerable room for improvement remains. This exercise deepens the understanding of the impact of the resolution framework and the importance of counterparties for its credibility and future applications.