The Bail-In Puzzle

Policy Letter No. 6, 2011

Jan Pieter Krahnen
Research Area:
Financial Intermediation
Jul 2011
debt restructuring, financial stability, bank bonds

Under the current conditions of a global financial crisis, notably in Europe’s banking industry, the governance role of bond markets is defunct. In fact, investors have understood that bank debt will almost always be rescued with taxpayers’ money. The widespread practice of government-led bank bailouts has thus severely corrupted the bond market, leading to the underestimation of risk and, as a consequence, the destruction of market discipline. Any feasible solution to the bank-debt-is-too-cheap problem will have to re-install true default risk for bank bond holders.

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