An Overview of the Issues

It is well known that the economic impact of the insolvency of banks poses different problems for society from the insolvency of non-financial companies and indeed from many other financial companies. These differences stem primarily from two causes: the holding of deposits and the spill-over from a problem in one bank to others and to the rest of the economy.1 The laws relating to insolvency try to provide a balance between the various groups exposed to the loss in the case of company failure – creditors, shareholders, customers, employees, and so on – and some equality of treatment of those within each group. In the latter respect this often involves measures to coordinate the interests of large numbers of people with individually small exposures and little power and information. Views differ across societies about the appropriate balance but it is normally only those directly involved who have a say. Courts can determine that the rules for sharing the cost are properly applied in each case. While it is only natural that those about to make losses would like to shift the burden onto others, the case for external assistance from taxpayers through the government is usually weak. The authorities are thus not normally directly involved unless they are exposed to the direct loss in the normal course of business.2 Having an efficient competitive economy involves entry, growth and exit of enterprises in a framework that gives confidence to the participants.3 This includes the orderly exit of insolvent banks.4