Taking the Moral Hazard Out of Banking: The Next Fundamental Step in Financial Reform

PSL Quarterly Review, Vol. 64, No. 257, pp. 105-142, 2011

38 Pages Posted: 28 Sep 2011

See all articles by Rainer Masera

Rainer Masera

Libera Università degli Studi Sociali (LUISS) Guido Carli

Date Written: September 28, 2011

Abstract

The path between financial meltdown and moral hazard in banking is, at best, narrow and impervious. During the financial crisis, public support became the standard response to save the banks in difficulty, heightening and broadening the moral hazard issue: subordinated/senior debt holders and large depositors were bailed out and equity holders were partially sheltered. In the Eurozone, the implicit promise to bail-out governments in difficulty has encouraged SIFIs and other financial operators to speculate on the yield differential between sovereigns and the ECB money market interest rates. The policy framework proposed here is two-pronged: the EFSF should evolve to permit more flexible and wide-ranging interventions, and be able to manage sovereign debt restructuring; with respect to SIFIs, very early corporate, market and supervisory responses are suggested. Intervention of supervisory authorities with mandatory (special) powers would occur before the threshold of non-viability and, on a gone-concern basis, in terms of a European resolution procedure.

Keywords: financial crisis, SIFIs, sovereign risk, moral hazard, resolution procedure

JEL Classification: G01, G28, H12

Suggested Citation

Masera, Rainer, Taking the Moral Hazard Out of Banking: The Next Fundamental Step in Financial Reform (September 28, 2011). PSL Quarterly Review, Vol. 64, No. 257, pp. 105-142, 2011, Available at SSRN: https://ssrn.com/abstract=1934617

Rainer Masera (Contact Author)

Libera Università degli Studi Sociali (LUISS) Guido Carli ( email )

00162 Rome, Roma
Italy

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