Bail-in and bank funding costs

Abstract

We evaluate the impact of the bail-in, the new resolution policy adopted in 2016 within the Bank Recovery and Resolution Directive, on the cost of funding for EU banks. We first estimate the change in spreads of credit default swaps on subordinated and senior bonds issued by EU banks through an event study around the period when the policy became effective. We find that risk premia of junior bail-in-able bonds raised more compared to senior bonds. The results, however, point to a great heterogeneity in the impact of the policy, both for individual banks and across countries, while a simple theoretical model suggests possible sources of this heterogeneity. We therefore regressed the abnormal values derived from the event study on bank characteristics and macroeconomic factors. We uncovered several factors explaining the larger cost of funds for some of the EU banks after the implementation of bail-in: banks with more problematic loans, less capitalized, and headquartered in countries with a higher risk premium on sovereign debt have experienced a larger rise in their funding costs when issuing subordinated bonds. Overall, our paper provides evidence that the adoption of bail-in has prompted a more accurate evaluation of bank risk by junior creditors, leading to an increase in the cost of funds for banks.