The Bail-In Puzzle

Publication: Policy Letter No. 6, 2011
Topic Area: Financial Institutions
Authors: Jan Pieter Krahnen
Date: Jul 2011
Keywords: debt restructuring, financial stability, bank bonds
Abstract:

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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