The economics of banking regulation in Europe: does the post-GFC bail-in regime effectively eliminate implicit government guarantees?

Abstract

This paper assesses the market effects of regulatory events associated with the implementation of a bail-in regime for failing European banks. The bail-in regime was designed to make banks efficiently resolvable in order to abolish Implicit Government Guarantees (IGGs). We use a seemingly-unrelated-regressions framework to estimate the effects on Credit Default Swap (CDS) spreads and equity returns of key events associated with the two cornerstones of the European bail-in regime, the Bank Recovery & Resolution Directive (BRRD) and the Single Resolution Mechanism Regulation (SRM-R), and other relevant events. Contrary to the regulations’ objectives, we find that regulatory events associated with the implementation of BRRD and SRM-R led to tighter CDS spreads and higher equity returns over the 2009–2017 period. The pattern varies with bank heterogeneity and is particularly pronounced for global systemically important banks (G-SIBs), i.e. banks whose systemic risk profile is deemed to be of such importance that the bank's failure would trigger a wider financial crisis and threaten the global economy, suggesting that the regime does not effectively solve the systemic problem of bailout expectations in the European banking sector.