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Research Handbook on Crisis Management in the Banking Sector

Research Handbook on Crisis Management in the Banking Sector

Research Handbooks in Financial Law series

Edited by Matthias Haentjens and Bob Wessels

In this timely Handbook, over 30 prominent academics, practitioners and regulators from across the globe provide in-depth insights into an area of law that the recent global financial crisis has placed in the spotlight: bank insolvency law.

Chapter 3: A fiscal backstop to the banking system

Dirk Schoenmaker

Subjects: economics and finance, financial economics and regulation, money and banking, law - academic, company and insolvency law, finance and banking law


The strength of a banking system ultimately depends on the strength of the sovereign behind it. This principle was reinforced during the 2007–09 Global Financial Crisis and the subsequent 2010–12 European Sovereign Debt Crisis. Well-known examples of a weak sovereign, which could not back-up its troubled banking system, are Iceland, Ireland, Portugal and Cyprus. Governments – assembled in the Financial Stability Board – aim to reduce their potential exposure to the banking system through several reforms. The major reform proposals to strengthen financial stability are twofold:1 (i) Reduce the probability of failure by increasing capital substantially; (ii) Reduce the impact of failure by imposing resolution plans, bail-in arrangements, as well as adopting structural reforms of the banking system. A key structural reform is the requirement to separate commercial and investment banking, as suggested by Volcker for the United States (US), Vickers for the United Kingdom (UK) and Liikanen for the European Union (EU). However, it can be questioned whether such separation will really limit the government’s potential exposure. Remember that the US government had to rescue several (lightly regulated) investment banks during the Global Financial Crisis. Another reform is the planned application of bail-in of (junior) creditors to reduce the need for taxpayers’ money. While bail-in can work very well in the case of idiosyncratic failures, it remains to be seen whether authorities dare to apply it during a severe banking crisis. Bail-in spreads the losses through the system and can thus cause contagion.

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