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February 09, 2018

IMF published staff discussion note on trade-offs in bank resolution. The note examines the economic forces that determine the relative costs and benefits of bail-ins and bail-outs. The note revisits the trade-off entailed in the decision of a policymaker on the relative role of bail-ins of private stakeholders and public bail-outs.

The first section of the note presents the theoretical model that provides a framework to assess the circumstances in which losses may need to be borne by the public sector, rather than private investors. The answer crucially hinges on the trade-off between the moral hazard costs associated with bail-outs and the potential spillovers arising from bail-ins. The second section discusses the empirical evidence that is consistent with the existence of moral hazard effects associated with bail-outs and of spillovers associated with bail-ins. The third section briefly discusses the recent reforms to enhance resolution frameworks, along with the progress in shifting the burden of a crisis to private investors, strengthening resolution frameworks, and improving the bail-in/out trade-offs by enhancing resolvability and increasing loss absorbency.

The note supports the ongoing reform agenda to provide resolution authorities with effective bail-in powers and stresses that frameworks should aim to minimize moral hazard associated with bailouts. Nonetheless, it also emphasizes the need to allow for sufficient, albeit constrained, flexibility to be able to use public resources in the context of systemic banking crises—when spillovers are significant and deemed likely to severely jeopardize financial stability. Furthermore, the analysis calls for continued efforts to enhance loss-absorbing capacity, ensure that holders of bail-in-able debt are those best situated to absorb losses, and improve arrangements for cross-border resolution. This is essential to further boost the effectiveness of bail-in powers and contain the risk of spillovers.

Related Link: Discussion Note

Keywords: International, Banking, Bank Resolution, Trade-offs, Bail-in, Bail-out, Resolution Framework, IMF

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