No. 594 - The EU bank insolvency framework: could less be more?

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by Giovanni Majnoni, Gabriele Bernardini, Andreas Dal Santo and Maurizio TrapaneseFebruary 2021

This paper shows that the present European framework for bank crisis management in the Banking Union (BU) follows multiple criteria that, when applied in combination, can generate unintended consequences that undermine the effectiveness of the system, highlighting a case of fallacy of composition. The paper suggests that a piecemeal reform would not be adequate to tackle the framework's shortcomings. A broader effort is required to streamline the current criteria into a single rulebook, achieving effectiveness through simplification.

The paper suggests that the experience of the US FDIC provides a useful benchmark. The adoption in the BU of a single and clear criterion - the Least Cost Test as in the US - makes it possible to fully protect taxpayers and to contain the value destruction caused by bank failures. It is suggested that its adoption by the BU would help frame a common approach to failing banks of all sizes and would provide a solution to the geographic and institutional fragmentation of the current set-up.

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