Precautionary recapitalisations: time for a review

05-07-2017

With the introduction of the Bank Recovery and Resolution Directive (BRRD), public capital contributions to insolvent banks should have become a thing of the past or at least an extremely unlikely eventuality. The supposedly exceptional precautionary recapitalisation of Banca Monte dei Paschi (MPS) seems to offer evidence of the contrary. Based on a review of the empirical literature and the resent resolution of Banco Popular and MPS, this paper argues that a precautionary recapitalisation facility can be in the taxpayers’ interest, but only under very specific circumstances and conditions. The current rules on precautionary recapitalisation and guidelines for the supervisory exercises used to determine the shortfall should therefore be revised. On the one hand, the current requirements are too flexible, leaving room for public capital injections into de facto insolvent banks, while on the other hand, the requirements imposed on the recapitalisation amounts are too rigid to allow the realisation of maximum economic returns.

With the introduction of the Bank Recovery and Resolution Directive (BRRD), public capital contributions to insolvent banks should have become a thing of the past or at least an extremely unlikely eventuality. The supposedly exceptional precautionary recapitalisation of Banca Monte dei Paschi (MPS) seems to offer evidence of the contrary. Based on a review of the empirical literature and the resent resolution of Banco Popular and MPS, this paper argues that a precautionary recapitalisation facility can be in the taxpayers’ interest, but only under very specific circumstances and conditions. The current rules on precautionary recapitalisation and guidelines for the supervisory exercises used to determine the shortfall should therefore be revised. On the one hand, the current requirements are too flexible, leaving room for public capital injections into de facto insolvent banks, while on the other hand, the requirements imposed on the recapitalisation amounts are too rigid to allow the realisation of maximum economic returns.