Implicit Bank Debt Guarantees: Costs, Benefits and Risks

Abstract

The expectation by market participants that public authorities might bailout the creditors of banks that are considered too important for financial system stability or another reason to be allowed to fail, is commonly referred to as an implicit guarantee. Public authorities do not have any explicit commitment to intervene; they may even honestly state that they not want to do so ex ante, but may feel compelled to do so ex post. A declared policy aim is to limit the value of implicit guarantees by making banks stronger, more easily resolvable in case of distress, as well as by imposing extra charges that rise as banks become more systemically important. As part of the latter approach, globally systemically important banks are identified and subjected to more costly and intrusive regulation. There is little evidence that specific approach has been successful so far. There is some evidence that the introduction of new resolution frameworks has been helpful, while the use of newly available resolution tools and the involvement of bank creditors in the burden sharing associated with bank failure resolution has significantly reduced the value of implicit bank debt guarantees, where it occurred. In that sense, actions speak louder than words.

Do Fintech and Cryptocurrency Initiatives Make Banks Less Special?

“…The costs include the perception that some banks are so "special" that their debt is implicitly insured by public authorities, which means they are unlikely to be forced to exit the market, at least not in an uncontrolled way. Current financial regulatory reform explicitly aims to reign in such expectations, although recent estimates of the value of implicit guarantees suggests the deed has not yet been accomplished (Schich, 2018).…”