Bail-in regimes lower costs of resolution for states – ECB paper

A working paper published by the European Central Bank looks at the different effects of bail-in and bail-out regimes on banks’ capitalisation.

In A structural model to assess the impact of bank capitalization changes conditional on a bail-in versus bail-out regime, Marco Gross, Tomasz Dubiel-Teleszynski and Javier Población present a method of valuing banks according to the prevailing resolution regime.

The authors’ model gives methods for estimating a wide range of variables. These include the value of banks’ equity and debt holdings. The model also estimates the value to the government of a bank being operated by private shareholders, or being bailed out and taken into state ownership. It gives methods for estimating such price and risk parameters as the funding cost spread and the banks’ probability of default.  

The authors say their model can be used to help inform decisions about the need for bank recapitalisations. They also find that the cost to the government of a failed bank, and the cost of resolution, is lower under a bail-in regime than under a bail-out regime. Their findings, they argue, support the rationale behind the European Union’s recent decision to move to a bail-in regime.