Finance: Research, Policy and Anecdotes

Bank resolution in Portugal and across the globe

My paper “Sharing the Pain? Credit Supply and Real Effects of Bank Bail-ins”, with Andre Silva and Samuel Da-Rocha-Lopes, has been accepted for publication in the Review of Financial Studies. This paper gauge the credit supply and real effects of the resolution of Banco Espirito Santo in Portugal in August 2014. The bank was split into a bad bank, sent into liquidation with equity holders and junior debtholders effectively bailed in, and a good bridge bank (Novo Banco) that continued operating. We find that firms exposed to the failed and resolved bank see a reduction in lending by Novo Banco, but can make up for it by borrowing more from other banks they already have relationships with. However, SMEs exposed to the failed and resolved bank experience a reduction in credit lines and those SMEs with low liquidity reserves before the shock reduced investment and employment, while increasing their liquid assets.    In summary, the resolution was not a panacea as there were some real sector effects, but the negative effects were contained. The pain was shared across bailed-in debtholders and some of the banks’ borrowers, but the taxpayer did not have to shoulder the burden, unlike in the case of bailouts.

 

I have discussed this paper before on my blog and am happy to report that the main message has not changed. But the reviewers and editor pushed us hard to think more carefully about what drives the result that lending by Novo Banco (the “good-bank” remainder of Banco Espirito Santo) went down. Were it the losses in BES? No, as the bridge bank was recapitalised during the resolution to its original level, well above the minimum.  Rather, it was the bail-in as part of a broader restructuring process, replacing management, extensive reorganisation and changes in risk management. This is different from bailouts, where management is not necessarily replaced and there is not necessarily a broader reorganisation.  

 

A second interesting result from the revised paper is that on the substitutability of cash reserves and credit lines. There is a clear differential effect between firms with high and low cash reserves before the shock. Those with high reserves can draw down their cash reserves thus making up for the loss in credit lines, while those with low reserves have to refill them after suffering a reduction in credit lines.

 

While this paper is a case study of one specific bank, in a new paper with Deyan Radev and Isabel Schnabel, we look at the effect of bank resolution frameworks across banks in 22 countries. Rather than specific bank failures, we focus on the reaction of banks’ systemic risk contribution after system-wide shocks across countries with different bank resolution frameworks.  This paper is still very much work in progress so I will leave the discussion for another day.