“Rescued Banks Back to the Market?” by Edoardo D. Martino (University of Amsterdam) and Andrea Perini (University of Florence) was published on 29 November 2023 in the EBI Working Paper Series No. 157.

Precautionary recapitalization is instrument of flexibility into the post-financial crisis regulatory framework whereby solvent but undercapitalized banks can receive capital aids under stringent conditions. Nonetheless, this instrument confronts a credibility challenge due to poorly articulated provisions and opportunistic behavior by National States. Specifically, the crucial but under investigated issues concern the persistent public ownership of financial institutions several years after the use of precautionary recapitalizations.

This is the first article directly providing an in-depth analysis of such critical issue, proposing an analytical framework to approach the matter. The key insight from this framework is a challenge to the consensus approach on the design of public interventions in banking that looks at the trade-offs among minimizing ex-ante moral hazard of bankers, preserving financial stability and protecting taxpayers. We contend that this approach is incomplete as it overlooks completely the ex-post effect of the intervention which may bring about significant social costs.

Against this framework, we delve into the current legal framework for precautionary recapitalization and provide a detailed analysis of its implementation in the cases of National Bank of Greece, Piraeus Bank, and Monte dei Paschi di Siena. The analysis identifies the key factors in precautionary recapitalizations, encompassing the assessment of institutional solvency, the timing of recapitalization, the type of instruments employed, and the political economy of the recapitalization process. This nuanced examination contributes to the studies aimed at enhancing the effectiveness of the overall supervision and resolution framework for EU banks.

Finally, we briefly confront our findings with the reform proposals on the matter put forward by the Commission in the Crisis Management and Deposit Insurance (CMDI) framework. We conclude that the proposed reform would result either in a useless instrument because of its rigidity or in potentially subject to abuse one because of the potential lax interpretation of the new norms. In either case, it would not serve the purpose of having a credible but flexible instrument to address crisis in a preventive manner.

To read the entire paper, please follow https://ssrn.com/abstract=4646777 or http://dx.doi.org/10.2139/ssrn.4646777.