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Catharsis - The real effects of bank insolvency and resolution

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  • Korte, Josef

Abstract

In general, banks play a growth-enhancing role for the real economy. However, distorted incentives for banks, depositors, and regulators in connection with bank insolvency may corrupt banks' credit allocation and monitoring decisions, leading to suboptimal real economic outcomes. A rules-based prompt resolution regime for insolvent banks may reestablish the incentive system and provide for economically superior credit allocation and monitoring. We test the hypothesis that regulatory insolvency has a cathartic effect using a large firm-level dataset and proposing a new indicator to measure the strength of catharsis. Employing an instrumental variable setup and an interaction approach, we try to overcome concerns about causality and potential endogeneity which are usually inherent to research into the real economic implications of bank regulation. We find a comparably stronger implementation of a hypothetical positive capital closure rule to have a positive and statistically as well as economically significant effect on individual firm growth - particularly for firms that are structurally more dependent on bank financing. Our findings are robust to various specifications. Investigating the transmission channels of the 'catharsis effect', we find that it essentially works through benefiting better quality firms and reallocating credit towards firms that need it most. Additional analyses suggest that the 'catharsis effect' works best in open banking systems that provide high access to international finance and, hence, mitigate potentially negative credit supply effects of insolvent bank liquidation. Taken together, our findings advocate stronger attention being given to incentive-compatible bank resolution regimes.

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  • Korte, Josef, 2013. "Catharsis - The real effects of bank insolvency and resolution," Discussion Papers 21/2013, Deutsche Bundesbank.
  • Handle: RePEc:zbw:bubdps:212013
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    Cited by:

    1. Marinč, Matej & Rant, Vasja, 2014. "A cross-country analysis of bank bankruptcy regimes," Journal of Financial Stability, Elsevier, vol. 13(C), pages 134-150.
    2. Ignatowski, Magdalena & Korte, Josef, 2014. "Wishful thinking or effective threat? Tightening bank resolution regimes and bank risk-taking," Journal of Financial Stability, Elsevier, vol. 15(C), pages 264-281.
    3. Pierpaolo GIANNOCCOLO & José Manuel MANSILLA-FERNÁNDEZ, 2017. "Bank Restructuring, Competition, and Lending Supply: Evidence from the Spanish Banking Sector," Departmental Working Papers 2017-16, Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano.

    More about this item

    Keywords

    bank insolvency; bank resolution; bank closure; bank regulation; finance and growth;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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