The Banking Union and evidence on bail‐ins and bailouts

• Published date: 01 September 2022
• Author: Ricardo Cabral
• Date: 01 September 2022
• DOI: http://doi.org/10.1111/eufm.12354

DOI: 10.1111/eufm.12354

ORIGINAL ARTICLE

The Banking Union and evidence on bail‐ins

and bailouts

Ricardo Cabral

Department of Economics, Lisbon School

of Economics and Management,

University of Lisbon, Lisbon, Portugal

Correspondence

Ricardo Cabral, Department of

Economics, Lisbon School of Economics

and Management, University of Lisbon,

Rua do Quelhas no. 6, 1200‐781 Lisbon,

Portugal.

Email: rcabral@iseg.ulisboa.pt

Abstract

This article analyzes the euro area's banking sector

regulatory framework, known as the Banking Union. It

shows how distressed banks' noncompliance with su-

pervisory, state aid, or central bank lending policies

can trigger the application of resolution or liquidation

measures. Further, it provides new evidence on large

banks distress episodes in the European Union and the

United States, suggesting that recapitalization is a more

cost‐effective policy instrument than resolution or li-

quidation. Finally, it argues that the Banking Union

lacks an appropriate recapitalization instrument for

borderline distressed banks and that a more nuanced

and structured stance on regulatory forbearance is

probably warranted.

KEYWORDS

Banking Union, financial stability, liquidation, regulatory

forbearance, resolution

JEL CLASSIFICATION

E58, G00, G21, G28

Eur Financ Manag. 2022;28:1079–1103. wileyonlinelibrary.com/journal/eufm © 2022 John Wiley & Sons Ltd.

|

1079

EUROPEAN

FINANCIAL MANAGEMENT

I thank an anonymous referee, John A. Doukas (the Editor), António Sampaio e Mello and Alicia Brewer (the Copy

Editor) for valuable comments that substantially improved the paper. The usual disclaimer applies. I acknowledge

financial support from the Foundation for Science and Technology, Portugal, project number UIDB/00685/2020, from

Project Ulysses, University of Madeira and from the Department of Economics, Lisbon School of Economics and

Management, University of Lisbon.

1|INTRODUCTION

Between 2012 and 2016, European Union (EU) policymakers designed and implemented a new

banking sector regulatory framework known as the Banking Union,

1

as well as a new banking

sector state aid framework (introduced through the 2013 Banking Communication of the

European Commission). To a large extent, the Banking Union—like the US Orderly Liquida-

tion Authority instrument and other provisions of the Dodd–Frank Act of 2010—adopts aca-

demic literature proposals that seek to minimize market discipline distortions caused by the

banking sector public safety net and to reduce the costs of banking crises (e.g., Admati

et al., 2013,2018; Admati, 2014; Alessandri & Haldane, 2011; Benston & Kaufman, 1988,1998;

Calomiris, 1999; Cochrane, 2014; James, 1991). The Banking Union thus aims to reduce bank

leverage, regulatory forbearance and moral hazard. It does so through more demanding leg-

islation and regulation, by transferring bank supervisory powers to a central authority (the

European Central Bank or ECB), through higher capital requirements and by modifying the

main distressed banking policy instrument from 2014 onward, replacing the bailout measure

through resolution and liquidation measures, while restricting bank bailouts.

The Banking Union foresees multiple triggers for the application of resolution or liquidation

measures, which can come into force well before bank capital is significantly depleted or even if

banks fully comply with capital requirements. Finally, the resolution instrument requires

substantial restructuring of bank liabilities through the bail‐in of shareholder equity, sub-

ordinated debt and senior debt, including a significant portion of bank deposits

(Hadjiemmanuil, 2016). Therefore, the Banking Union constitutes an important application of

the literature on bank capital requirements, regulatory forbearance and moral hazard (Admati

et al., 2013; Benston & Kaufman, 1988).

This article argues that the results are mixed. The Banking Union has resulted in higher

capital ratios, a marked reduction in nonperforming loan (NPL) levels and distressed banks'

deleveraging. Further, the new framework has clearly reduced regulatory forbearance as en-

visaged (Benston & Kaufman, 1988,1998). However, contrary to the expectations of lower costs,

the new framework has also resulted in very high costs to taxpayers, with combined fiscal

expenditures of tens of billions of euros. It has also had large redistributive effects, as private

sector bank shareholders and creditors were expropriated of financial assets, cumulatively also

in the tens of billions of euros.

In at least some instances, these costs have been higher than in previous banking sector

crises. For example, in the case of Portugal, between 2013 and 2020, injections of taxpayer

funds into banks, foremost in the context of resolution measures, amounted to 7.8% of the 2019

gross domestic product (GDP).

2

In the same period, the losses incurred by shareholders and

creditors of the two banks that were subject to resolution measures (Banco Espírito Santo, or

BES and Banco Internacional do Funchal, or Banif) are estimated at 8.0% of the 2019 GDP. This

banking crisis appears to have been the most severe in Portugal since the end of the 19th

century.

3

1

The Banking Union is defined here as including the ‘single rulebook’of European directives and regulations and

new European institutions charged with implementing bank supervision and resolution rules. The Banking Union

is mandatory for euro area member states.

2

Figures from Banco de Portugal (2019) and author calculations.

3

The previous serious banking crisis occurred in 1929–1931 and saw two banks fail that, however, were not among the

five largest (Silva & Amaral, 2011; Valério et al., 2007).

1080

|

EUROPEAN

FINANCIAL MANAGEMENT

CABRAL