European Significant Bank Stock Market Volatility: Is there a Bail-In Effect?

Paola Leone,Pasqualina Porretta,Luca Riccetti

doi:10.5539/ijbm.v14n5p32

Abstract

In 2016 the &ldquo;bail-in&rdquo; tool, set by the European Bank Recovery and Resolution Directive (BRRD), started to enter into force: shareholders of European banks lose their money in the case of bank rescue. Before the &ldquo;bail-in&rdquo; mechanism was introduced, governments often performed bail-out of distressed banks. The larger risk born by shareholders can be observed in the growth of stock market volatility. We implement a panel data analysis on a sample of large European banks and find that in 2016 stock market volatility changes in a way that is theoretically consistent with the introduction of the &ldquo;bail-in&rdquo;. Moreover, Italy shows an even higher volatility, probably due to retail investors owning bank shares, who could have understood the risk only after the burden sharing of four Italian banks in November 2015. These findings can be a warning about market efficiency, with implications for the systemic risk of a &ldquo;bail-in&rdquo; procedure.

Highlights

In order to reduce costs for the tax payer related to bank bail-out, the European Parliament adopted a framework named Bank Recovery and Resolution Directive (BRRD)(Note 1) to give comprehensive and effective arrangements to the financial authorities to deal with failing banks
We start with a pooled ordinary least squares regression (POLS), and with static panel approaches, that is with random effects (RE) and with fixed effects (FE)
As already explained in the Methodology section, we analyze the dataset with a pooled ordinary least squares regression (POLS), and with the static panel approach, that is with random effects (RE) and with fixed effects (FE)

Summary

Introduction

In order to reduce costs for the tax payer related to bank bail-out, the European Parliament adopted (in spring 2014) a framework named Bank Recovery and Resolution Directive (BRRD)(Note 1) to give comprehensive and effective arrangements to the financial authorities to deal with failing banks. The hierarchy for the bail-in of creditors follows a creditor waterfall whereby the junior liabilities are bailed-in first, followed by the (more senior) tranches upon depletion of each previous layer (see Table 1). In this manner, the costs of the bank resolution fall in theory not upon the taxpayers but, according to the established order, on bank shareholders and creditors. Where it is not possible to pursue the banking equilibrium conditions or to guarantee an adequate capitalization, a Resolution Fund intervention is expected up to a maximum of 5% of total liabilities, subordinated to the condition that at least 8% of total liabilities have already been subject to bail-in mechanisms

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Conclusion