Too-International-to-Fail? Supranational Bank Resolution and Market Discipline

Book excerpt: Supranational resolution of insolvent banks does not necessarily improve welfare. Supranational regulators are more inclined to bail-out banks indebted towards international creditors because they take into account cross-border contagion. When banks' creditors are more likely to be bailed out, market discipline decreases and risk-taking by indebted banks increases. Depending on the trade-off between giving the right incentives ex ante and limiting contagion ex post, both a national and a supranational resolution framework can be optimal. In particular, if market discipline is low under both national and supranational resolution mechanisms, supranational resolution improves welfare as it stimulates interbank trade.