New Bank Resolution Mechanisms: Is It the End of the Bailout Era?

Abstract

We study the effectiveness of three common bank resolution mechanisms: bailouts, bank sales, and ‘bad banks’. We first apply the financial fragility model of Goodhart et al. (2005, 2006a) to analyze the impact of these resolution mechanisms on bank behavior. We then use a novel bank-level database on 39 countries that used these resolution mechanisms during 1992-2017 and analyze the relationship between the mechanisms applied and subsequent bank performance. We find that the effectiveness of resolution mechanisms depends crucially on the timing and severity of crises. While mergers can deliver good results at the beginning of a crisis, this is less likely at later stages of a crisis. In the event of severe crises, mechanisms aimed at restructuring bank balance sheets are most likely to deliver positive results. We find no support for bank bailouts as an optimal strategy. A calibration exercise shows that the effectiveness of resolution mechanisms to mitigate systemic risk declines with the severity of crises.