Mr Guennewig, has the US government not learned the lessons from the Great Financial Crisis?
Maxi Guennewig: Lessons were learned. Yet, the current bank regulation may not be optimal to prevent financial fragility in times of crisis. Let’s look at the reforms first: Before 2008, governments could only rescue failing banks considered “too big to fail” by injecting costly public funds, i.e. using bailouts. Nowadays, governments can put failing banks into resolution which allows governments to impose losses on bank creditors. During a bank resolution, governments continue to provide partial deposit insurance with the goal of curbing financial fragility – and this is important.
We find, if the government provides a sufficiently large amount of deposit insurance, banks finance exclusively using insured and uninsured deposits. This is what we see in the actual numbers. Upon arrival of unfavourable news about the value of bank assets, uninsured depositors withdraw in anticipation of intervention. This imposes losses on insured depositors. The fragility resulting from the anticipation of bail-ins thus stands in the way of resolution, and the government is forced to conduct bailouts after all.
In other words, do banks inflict their losses on the government via uninsured deposits?
Maxi Guennewig: Yes. By issuing uninsured deposits, banks are able to impose losses on insured depositors and thus on the government.
What is your recommendation to policymakers?
Maxi Guennewig: Policymakers who design banking regulation should take this mechanism into account. Otherwise, the post-crisis reforms may fail to achieve their purpose and spur financial fragility instead. The potential costs for governments are huge.