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Believing in bail-in? Market discipline and the pricing of bail-in bonds

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  • Ulf Lewrick
  • José María Serena Garralda
  • Grant Turner

Abstract

Bail-in regulation is a centrepiece of the post-crisis overhaul of bank resolution. It requires major banks to maintain a sufficient amount of "bail-in debt" that can absorb losses during resolution. If resolution regimes are credible, investors in bail-in debt should have a strong incentive to monitor banks and price bail-in risk. We study the pricing of senior bail-in bonds to evaluate whether this is the case. We identify the bail-in risk premium by matching these bonds with comparable senior bonds that are issued by the same banking group but are not subject to bail-in risk. The premium is higher for riskier issuers, consistent with the notion that bond investors exert market discipline on banks. Yet the premium varies pro-cyclically: a decline in marketwide credit risk lowers the bail-in risk premium for all banks, with the compression much stronger for riskier issuers. Banks, in turn, time their bail-in bond issuance to take advantage of periods of low premia.

Suggested Citation

  • Ulf Lewrick & José María Serena Garralda & Grant Turner, 2019. "Believing in bail-in? Market discipline and the pricing of bail-in bonds," BIS Working Papers 831, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:831
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    References listed on IDEAS

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    Cited by:

    1. Vittoria Cerasi & Paola Galfrascoli, 2021. "Bail-in and Bank Funding Costs," Working Papers 472, University of Milano-Bicocca, Department of Economics, revised Jul 2021.
    2. Vittoria Cerasi & Stefano Montoli, 2020. "Bank resolution and multinational banks," Working Papers 447, University of Milano-Bicocca, Department of Economics, revised Jul 2020.
    3. Li, Shanshan & Gong, Di & Lu, Liping, 2024. "Bail-ins and market discipline: Evidence from China," International Review of Economics & Finance, Elsevier, vol. 93(PB), pages 51-68.
    4. Koetter, Michael & Krause, Thomas & Sfrappini, Eleonora & Tonzer, Lena, 2022. "Completing the European Banking Union: Capital cost consequences for credit providers and corporate borrowers," European Economic Review, Elsevier, vol. 148(C).
    5. Martin Indergand & Gabriela Hrasko, 2021. "Does the market believe in loss-absorbing bank debt?," Working Papers 2021-13, Swiss National Bank.
    6. Lindstrom, Ryan & Osborne, Matthew, 2020. "Has bail-in increased market discipline? An empirical investigation of European banks’ credit spreads," Bank of England working papers 887, Bank of England.
    7. Merton, Robert C. & Thakor, Richard T., 2022. "No-fault default, chapter 11 bankruptcy, and financial institutions," Journal of Banking & Finance, Elsevier, vol. 140(C).
    8. Giuliana, Raffaele, 2022. "Fluctuating bail-in expectations and effects on market discipline, risk-taking and cost of capital," ESRB Working Paper Series 133, European Systemic Risk Board.

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    More about this item

    Keywords

    too big to fail; banking regulation; TLAC; financial stability;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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