Catharsis—The real effects of bank insolvency and resolution

Abstract

implemented by relating bank assets that have been resolved after undercutting a specic capital ratio to all bank assets of banks that have undercut this ratio. Hence, the indicator essentially captures the idea of how rules-based failed banks are resolved. In addition,we construct a panel of more than 2 million rm-year observations containing economic performance data of non-nancial rms. As the relation between real economic growth and the nancial system might be prone to reverse causality and endogeneity issues, we employ an identication framework consisting of several econometric techniques which helps us establish causality.Our results conrm the hypothesis of a positive`catharsis eect' and yield three important ndings. First, we nd a comparably stronger implementation of a hypothetical positive capital closure rule to have a positive and statistically as well as economically signicant eect on individual rm growth. To underline the causality of this relation, we show that the eect is particularly pronounced for rms that are structurally more dependent on bank nancing. With regard to economic signicance, our results suggest that the`catharsis eect' can cause a dierence of roughly 0.4 to 0.6 percentage points in rms' growth rates. Second, investigating the transmission channels of the`catharsis eect', we nd that it essentially works through beneting better quality rms (`quality channel') and reallocating credit towards rms that need it most (`quantity channel').Third, additional analyses suggest that the`catharsis eect' works best under specic economic conditions, for example in open banking systems that provide high access to international nance and hence mitigate potential negative consequences of insolvent bank liquidation. All our ndings are robust to various specications.Taken together, our results strongly underline the signicance of bank insolvency and resolution for the real economy. AbstractIn general, banks play a growth-enhancing role for the real economy. However, distorted incentives for banks, depositors, and regulators in connection with bank insolvency may corrupt banks' credit allocation and monitoring decisions, leading to suboptimal real economic outcomes. A rules-based prompt resolution regime for insolvent banks may reestablish the incentive system and provide for economically superior credit allocation and monitoring. We test the hypothesis that regulatory insolvency has a cathartic eect using a large rm-level dataset and proposing a new indicator to measure the strength of catharsis. Employing an instrumental variable setup and an interaction approach, we try to overcome concerns about causality and potential endogeneity which are usually inherent to research into the real economic implications of bank regulation. We nd a comparably stronger implementation of a hypothetical positive capital closure rule to have a positive and statistically as well as economically signicant eect on individual rm growth -particularly for rms that are structurally more dependent on bank nancing. Our ndings ...

Wishful Thinking or Effective Threat? Tightening Bank Resolution Regimes and Bank Risk-Taking

“…Whereas these papers focus primarily on the eects of government bailout policies, we investigate the eects of an ex ante disciplining regulatory approach. Although an economic rationale for such disciplining resolution policies has previously been modeled (Acharya, 2009;Acharya and Yorulmazer, 2008;Perotti and Suarez, 2002), empirical evidence is limited with regard to the (non-)application of resolution rules by regulators (Brown and Dinç, 2011;Kasa and Spiegel, 2008;Korte, 2013). One vital implication of resolution regimes, however, has thus far mostly been unevaluated: the eects of their tightening on bank behavior.…”

“…Empirical evidence on resolution policies is, however, mostly limited to the (non-)application of resolution rules (Brown and Dinç, 2011;Kasa and Spiegel, 2008;Korte, 2013). To the best of our knowledge, there has not been any study thus far that empirically investigates the eects of tightening resolution regimes on bank risk-taking.…”

Wishful thinking or effective threat? Tightening bank resolution regimes and bank risk-taking

“…Whereas these papers focus primarily on the e ects of government bailout policies, we investigate the e ects of an ex ante disciplining regulatory approach. Although an economic rationale for such disciplining resolution policies has previously been modeled (Acharya, 2009;Acharya and Yorulmazer, 2008;Perotti and Suarez, 2002), empirical evidence is limited with regard to the (non-)application of resolution rules by regulators (Brown and Dinç, 2011;Kasa and Spiegel, 2008;Korte, 2013). One vital implication of resolution regimes, however, has thus far mostly been unevaluated: the e ects of their tightening on bank behavior.…”

“…However, the validity of the di erence-in-di erence approach relies upon the identifying assumption of a parallel trend between the treatment and control groups in the absence of treatment. While we presented 38 Note that the tests can only be conducted on the BHC level because of stock market data availability. 39 With regard to the de nition of the treatment period and the pre-and post-treatment periods, we have also employed alternative variables computed over 8, 6, and 4 quarters.…”

“…Empirical evidence on resolution policies is, however, mostly limited to the (non-)application of resolution rules (Brown and Dinç, 2011;Kasa and Spiegel, 2008;Korte, 2013). To the best of our knowledge, there has not been any study thus far that empirically investigates the e ects of tightening resolution regimes on bank risk-taking.…”