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Bank Creditors, Moral Hazard and Systemic Risk Regulation

Policy Exchange recently published a new report on bailouts arguing that there should be a semi-automatic procedure to recapitalise troubled banks whereby bank bonds are converted into equity.

This report, by author Andrew Lilico, considers the economic and ethical perils of state guarantees for the creditors of banks.  It argues that such guarantees mean that (relative to what would otherwise have been the case):
•    There will be a higher proportion of bonds in the capital structure;
•    Capital buffers will fall, and the riskiness of bank balance sheets will rise;
•    Liquidity ratios will fall;
•    Remuneration schemes will involve more risk-taking; and
•    The balance sheet of the banking sector will rise, potentially to the point at which it starts to materially raise the risk of sovereign default.

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