Did the BRRD improve market discipline?

Authors: Jannic Cutura (Goethe University)

Title: Did the BRRD improve market discipline?

Abstract: Yes. The revision of the regulatory framework for banks and in particular the emergence of bail-in procedures are widely believed to have been a fruitful endeavour. Whether these reforms are perceived as a credible threat remains an active field of research with important policy implications. By exploiting the differential impact of the Banking Recovery and Resolution Directive (BRRD) on bank bonds, I am able to simulate a quasi natural experiment using a difference-in-difference framework. The identification strategy builds on the fact that the bailin tool is not be used until 01/01/2016, effectively granting am implicit guarantee for bank bonds maturing before. I show that bank bonds that unexpectedly became subject to BRRD bailin-tool exposure, i.e. bonds maturing after 01/01/2016 face increased yield spreads (a bailin premium) of 0.1 percentage points compared to the control group after the legislatives process, while there was no such difference before the legislative process. The same pattern cannot be observed on non-bank corporate bonds. Placebo tests among non-treated bonds confirm my findings. Bonds of peripheral banks are stronger affected. For globally systemic institutions, the effect is less significant. The results are robust to various fixed effects. This represents evidence that the BRRD indeed increased market discipline.