Expected Bail-in Costs, Bank Risk-taking and Real Effects

We estimate expected bail-in costs for an international sample of banks by comparing spreads of credit default swaps (CDS) that only differ in terms of whether they insure against the bailing in of a distressed banks’ creditors. Using these estimated bail-in costs we study bank risk taking and the resulting impacts on borrowers. We estimate on average 17% higher CDS spreads due to bail-in, which is higher in riskier countries, in countries with stronger and more independent regulators, as well as after general elections. We find that expected bail-in costs reduce bank risk-taking, consistent with enhanced market discipline. Finally, riskier firms obtain loans with a higher spread, and experience lower investments and asset growth, if they borrow from banks with high bail-in costs