Financial stability considerations on bail-in

This paper provides an economic analysis of the challenges to the bail-in regime in terms of its ability to affect the structure of incentives within large banks and to solve the problem posed by intermediaries that are classed as 'too big to fail' (TBTF). It first explains the peculiar role of large banks in the modern financial system and the impact of their failures on financial stability – both of which aspects are invoked to justify their differential treatment in a crisis. This discussion of the rationale for a bail-in regime helps understand the economic basis and the minimum conditions for the tool to be applied efficiently. The paper shows that European bail-in regulations involve complex rules and mechanisms that can be accompanied by discretionary aspects, potentially leading to uncertainties in the application of the procedure and difficulties in in achieving its objectives. A credible regulatory framework and clear decision-making processes would strengthen market discipline and reduce moral hazard. Finally, the paper argues that the bail-in procedure seems to be less viable, from a functional perspective, in the instance of a banking crisis with potentially systemic implications.