28 January 2014

Bundesbank/Dombret: The state as a banker?

Dombret called for credible bail-in procedures through higher capital buffers. He maintained that the state was not a good banker, and that it should only take on this role in exceptional cases.

Conclusion

There is a close relationship between the state and the banks due to implicit guarantees. This is not in line with the core principles of a market economy. These guarantees are threatening to destroy the close connection between risk-taking and liability and have created wrong incentives for the risk-taking behaviour of banks. Thereby the social costs of a failure of a big bank have increased. Given these high costs, a bail-out seemed ultimately inevitable.

To overcome this situation, we need well-designed and credible bail-in procedures. The practicability of resolution regimes requires coordination under the institutional setting as foreseen by the Single Resolution Mechanism. And we have to reduce the overall costs of a failure. Without reducing these costs, any bail-in procedure would lack credibility. High capital buffers would reduce the overall costs of letting a systemically important bank fail. Hence, practicable bail-in procedures and higher capital buffers are two sides of the same coin.

If we follow this approach in real life, we have the opportunity to make important headway towards redrawing the lines between the public and the financial sectors, between the state and banks. And thus we also have the opportunity to restore confidence in our banking sector, our public sector and in our economic market system as a whole in the spirit of those who advocated our social market economic system so brilliantly, in the spirit of Ludwig Erhard and the founding fathers of the social market economy.

To sum up:

First, blurring the lines between the state and banks threatens to destroy the unity of risk-taking and liability.

Second, redrawing those lines calls for credible and practicable bail-in procedures.

Third, for these procedures to be credible, the overall costs of a failure have to be reduced through higher capital buffers.

Fourth, the state is not a good banker and should not try to become a banker. It should only take on this role in the most exceptional cases, if at all.

Full speech

© Deutsche Bundesbank