The European Bank Recovery and Resolution Directive: a market assessment

Livia Pancotto, Owain ap Gwilym, Jonathan Williams

Research output: Contribution to journalArticle

Abstract

This paper provides evidence of the impact of the new European bank resolution regime on the sovereign-bank nexus. The implementation of the Bank Recovery and Resolution Directive (BRRD) is considered as an exogenous shock which provides the setting for a natural experiment. This investigation tests the financial markets’ perception of the effectiveness of the new rules in weakening the tight interconnectedness between sovereign and bank risk. A Difference-in-Differences (DiD) approach is adopted, building evidence from the Credit Default Swap (CDS) market for banks and nonfinancial corporates over the period 2011-18. The main findings do not indicate a significant weakening in the interaction between bank and sovereign CDS spreads, compared to the corresponding evidence for the non-financial corporate sector. An overall narrowing of the gap between bank and sovereign risk occurs, which initially implies a lack of credibility of the BRRD in financial markets. However, substantial cross-country variations are identified, particularly for Italy and non-euro area countries. These insights make a significant contribution to the policy debate on effective regulation of the sovereign-bank nexus, in the light of recent developments in the EU postcrisis reform agenda.
Original languageEnglish
Article number100689
Number of pages16
JournalJournal of Financial Stability
Volume44
Early online date27 Jul 2019
DOIs
Publication statusPublished - 31 Oct 2019

Keywords

  • BRRD
  • sovereign-bank nexus
  • CDS

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    Pancotto, L., ap Gwilym, O., & Williams, J. (2019). The European Bank Recovery and Resolution Directive: a market assessment. Journal of Financial Stability, 44, [100689]. https://doi.org/10.1016/j.jfs.2019.100689