Getting Bank Governance Right - The Interplay between the Resolution Framework and the Role of Creditors, with an Application to EU Law

Abstract

Shareholders are the residual claimants on the assets of a corporation. Creditors are fixed claimants whose interest lies in the solvency of the borrower. Consequently, shareholders are usually thought to have optimal incentives to maximise the value of the corporation.

The article challenges this common wisdom in banking and proposes to reform bank governance granting (some) ex-ante governance rights to bank creditors. This aims at fine-tuning bank governance and incumbent substantive regulation, in particular the resolution framework for distressed banks, and enhance the quality of decision-making of banks in terms of risk-taking. At the same time, the proposed reform should increase the ex-ante credibility of resolution.

The second part of the article operationalises this construct focusing on the specific case of the European Banking Union and discusses the design of the governance status of bail-inable creditors.

The analysis demonstrates how bail-inable creditors can correct for shareholders’ perverse incentives and make debt governance work in banking. The policy proposal advanced in the paper would complement substantive regulation and prudential oversight. The governance role of creditors has the potential to be particularly helpful in preventing disproportionate risk-taking decisions in good times, when regulatory and supervisory standards are lax and systemic risk piles-up.