Essays on the Credibility of Bail-in

This thesis groups three empirical papers on the topic of the bail-in regime. The leitmotiv that links all three papers is bail-in credibility, namely the perception of market participants about the effectiveness of the bail-in regime. Bail-in credibility is crucial for the bail-in regime to take hold as puzzling rules may both provide ample discretion to involved authorities, which casts some shadows regarding the an and quantum of the application of the bail-in tool, and also hamper investor’s predictability of the outcome. Uncertainty would, thus, cause turbulence on the debt market as some debtholders may overprice risk, causing higher funding costs which may undermine growth as a result of decreased lending capacity, whereas others may underprize risk, therefore, incentivizing moral hazard. The mispricing of debt instruments may, in the case of unexpected bail-in application, cause an overreactive price correction that may result in a liquidity freeze and consequent collapse of the interbank market. A credible bail-in regime is thus required as a pre-condition for its effective implementation. In the first paper, using a diff-in-diff analysis, we compare the subordinated bonds yields’ reaction to the implementation of the directive (EU) 2017/2399 between EU G-SIBs and smaller banks. We find an increase of subordinated bonds’ yields of EU G-SIBs relative to smaller banks between .24 and .31 basis points. We claim that the directives’ provisions enhance the bail-in regime, therefore, increasing the subordinated bondholders’ expectations of bail-in who, accordingly, reprice bonds’ yield. Moreover, we draw conclusions on the higher risk profile of subordinated bondholders following the implementation of the European bank resolution framework and suggest the effectiveness of its measures in restoring market discipline. In the second paper, we study the senior unsecured bondholders’ bail-in expectations and market monitoring activity following the events of the bail-in legislative process aimed at introducing new tools for subordination. To measure bail-in expectations, we use a difference in differences approach that compares the reaction to the bail-in events examined of bailinable bonds to the reaction of non-bailinable bonds. In a similar vein, we measure senior unsecured bondholders’ monitoring activity by using a triple differencing analysis that compares the yield-risk sensitivity reaction of senior unsecured bonds with respect to that of non-bailinable ones. A placebo test is also performed to link the results to the legal specificities of the bail-in instead of generic risk. Our results point out unaffected bail-in expectations by senior unsecured bondholders who, accordingly, do not enhance their pricing of banks’ risk. Regarding the third paper, Some controversial cases of bail-in in the emerging countries have raised the question about whether it is appropriate or not for those countries to have in place a regulation for the bail-in. To assess appropriateness, this paper investigates bail-in credibility among investors, as crucial condition for its smooth implementation, by measuring the yield-spread between bailinable and non bailinable bonds. We then compare the yield-spread of banks located in emerging countries which have in place a framework for the bail-in to the comparable yield-spread measured for banks located in emerging countries without such framework. The comparison permits to detect whether there is a significant difference between the two spreads, which would suggest that bail-in regulation has been deemed credible by market participants where enforced, or not, which in this case would signal a problem of credibility. Our results point out a significantly higher yield-spread for banks located in emerging countries which have adopted a framework for the bail-in of creditors.This thesis groups three empirical papers on the topic of the bail-in regime. The leitmotiv that links all three papers is bail-in credibility, namely the perception of market participants about the effectiveness of the bail-in regime. Bail-in credibility is crucial for the bail-in regime to take hold as puzzling rules may both provide ample discretion to involved authorities, which casts some shadows regarding the an and quantum of the application of the bail-in tool, and also hamper investor’s predictability of the outcome. Uncertainty would, thus, cause turbulence on the debt market as some debtholders may overprice risk, causing higher funding costs which may undermine growth as a result of decreased lending capacity, whereas others may underprize risk, therefore, incentivizing moral hazard. The mispricing of debt instruments may, in the case of unexpected bail-in application, cause an overreactive price correction that may result in a liquidity freeze and consequent collapse of the interbank market. A credible bail-in regime is thus required as a pre-condition for its effective implementation. In the first paper, using a diff-in-diff analysis, we compare the subordinated bonds yields’ reaction to the implementation of the directive (EU) 2017/2399 between EU G-SIBs and smaller banks. We find an increase of subordinated bonds’ yields of EU G-SIBs relative to smaller banks between .24 and .31 basis points. We claim that the directives’ provisions enhance the bail-in regime, therefore, increasing the subordinated bondholders’ expectations of bail-in who, accordingly, reprice bonds’ yield. Moreover, we draw conclusions on the higher risk profile of subordinated bondholders following the implementation of the European bank resolution framework and suggest the effectiveness of its measures in restoring market discipline. In the second paper, we study the senior unsecured bondholders’ bail-in expectations and market monitoring activity following the events of the bail-in legislative process aimed at introducing new tools for subordination. To measure bail-in expectations, we use a difference in differences approach that compares the reaction to the bail-in events examined of bailinable bonds to the reaction of non-bailinable bonds. In a similar vein, we measure senior unsecured bondholders’ monitoring activity by using a triple differencing analysis that compares the yield-risk sensitivity reaction of senior unsecured bonds with respect to that of non-bailinable ones. A placebo test is also performed to link the results to the legal specificities of the bail-in instead of generic risk. Our results point out unaffected bail-in expectations by senior unsecured bondholders who, accordingly, do not enhance their pricing of banks’ risk. Regarding the third paper, Some controversial cases of bail-in in the emerging countries have raised the question about whether it is appropriate or not for those countries to have in place a regulation for the bail-in. To assess appropriateness, this paper investigates bail-in credibility among investors, as crucial condition for its smooth implementation, by measuring the yield-spread between bailinable and non bailinable bonds. We then compare the yield-spread of banks located in emerging countries which have in place a framework for the bail-in to the comparable yield-spread measured for banks located in emerging countries without such framework. The comparison permits to detect whether there is a significant difference between the two spreads, which would suggest that bail-in regulation has been deemed credible by market participants where enforced, or not, which in this case would signal a problem of credibility. Our results point out a significantly higher yield-spread for banks located in emerging countries which have adopted a framework for the bail-in of creditors