Are Bank Resolution Funds Necessary?

The Commission proposes the establishment of ex ante resolution funds, funded by a levy on banks, to facilitate the resolution of failing banks in ways which avoid contagion, allow the bank to be wound down in an orderly manner and in a timeframe which avoids the “fire sale” of assets.

This should create a harmonized network of national funds linked to a set of coordinated national crisis management arrangements. The Commission also thinks that an EU Resolution Fund is possible in the longer term.

However, many think that the proposal institutionalizes moral hazard and will encourage banks to hold riskier asset portfolios. France and the UK in particular do not support the idea, and prefer to use the proceeds from any bank tax to finance their budgets.

So are bank resolution funds really necessary? It depends how you look at it. I very much like the analysis by Anthony M. Santomero and Paul Hoffman, saying that:

“(T)hese policy options may offer some hope to sustain the institutions’ lending capacity and consumer confidence for a short period of time. However, in the end, all of these options are no replacement for sound bank management and a sound balance sheet.”

I also don’t see how such funds will resolve typical weaknesses of the legal framework that have resulted in (i) incentives to postpone adequate treatment of failing banks; (ii) higher costs for bank resolution; and (iii) weaknesses in the banking system itself.

Stefano Micossi has said it quite clearly: if supervisors behave correctly, then large residual losses from bank failures become unlikely.

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