Implementing a European Bail-In Regime: Do BRRD & SRM-R Effectively Eliminate Implicit Government Guarantees in the European Banking Sector? An Empirical Analysis

Abstract

During the last decade, policymakers have implemented a European bank resolution regime, which includes the Bank Recovery & Resolution Directive and the Single Resolution Mechanism Regulation, designed to make banks resolvable and to abolish bailout expectations, i.e. implicit government guarantees (IGGs). The regime strives to make banks’ debt bail-in-able and to make government bailouts of banks the rare exception. The overall research objective of this paper is to measure the effectiveness of this regime in terms of bailout expectations in the form of funding advantages. Specifically, we examine market reactions to regime implementation, using an event- study framework to quantify the impact of key legal events on credit default swap (CDS) spreads and equity returns. We control for a wide range of variables to address endogeneity concerns raised with regard to omitted variables in prior work. Our uni-variate and multivariate analysis results suggest that the European bail-in regime alone does not effectively eliminate IGGs. On the contrary, CDS spreads, especially among global systemically important banks, are tightening and equity returns are increasing. This indicates that the regime inadequately solves the systemic problem of bailout expectations in the market.