We have been working on this paper for quite some time, but the current crisis makes it actually a very timely paper. As the global economy descends into recession, there are rising worries about the ability of banking systems across the globe to withstand the sharp, and synchronized, downturn. Over the past decade, countries across the globe have established or upgraded their legal and regulatory frameworks for resolving banks in distress. The question is whether these frameworks are also fit for purpose in a systemic banking crisis.
In recent work with Deyan Radev and Isabel Schnabel, we have compiled a database on resolution frameworks across 22 member countries of the Financial Stability Board (FSB) and assess how the systemic risk contributions of banks in these countries change if the global economy or financial system is hit by system-wide shocks.
First, based on the FSB’s 12 Key Attributes of an effective bank resolution framework, we construct an index of the comprehensiveness of bank resolution frameworks. Among the critical components of a comprehensive bank resolution regime are:
While we see a general trend of countries adopting more comprehensive resolution frameworks over time, there are some noteworthy observations:
We then compare the changes in banks’ DCoVaR across 760 banks and 22 countries with different bank resolution frameworks after system-wide shocks, including negative system-wide shocks (such as Lehman Brothers’ collapse in 2008) and positive system-wide shocks (such as Mario Draghi’s ‘whatever it takes’ speech in 2012).
Our results show:
Overall, our results lend support to theories that focus on the negative stability effects of bank resolution regimes designed for idiosyncratic bank failures during system-wide shocks. These theories posit that during systemic bank distress a rule-based system that ties regulators’ hands can result in bank runs and contagion if regulators have private information about bank performance and can destabilize the financial system in the middle of a crisis, through direct interlinkages of banks holding each other’s claims, as well as information effects and sudden reassessment of bank risk. While resolution regimes seem fit for purpose for resolution of individual banks, they may be counterproductive during systemic distress situations.
7. May, 2020