Helping Europe's Zombie Banks? Open Questions Regarding the Designated Use of the European Bank Resolution Regime

Abstract

This paper will not address the common sense response to the problem of a banking crisis that would be to prevent banks from failing. The current EU financial stability framework is addressing this task by ensuring that banks are adequately capitalised and supervised. Instead, it will examine the proposed European bank resolution regime, which does not aim at preventing failure but at reducing the impact of failure. Though it may not be its main purpose, an efficient bank resolution regime contributes to the prevention of bank failure by reducing a moral hazard as this may prevent a bank’s management and executives from engaging in excessive risk in cases where they can no longer trust in the government to use public funds to offset bad speculation. Under an efficient bank resolution regime, a failing bank would be subject to a resolution process, and its management and owners would have to face consequences and suffer losses for taking disproportionate risks. This paper will indicate that the upcoming European bank resolution regime does focus less on handling the scenario of an abrupt failing financial institution (a "Lehman scenario") and more on addressing the current problem of the slow recapitalization of European banks (a "zombie bank scenario").