Rescued Banks back to the market? The Theory, Practices and Future Perspectives of the EU Precautionary Recapitalization

The key policy objective of the post-financial crisis is to ban bailouts, especially for solvent banks. Precautionary recapitalization is an instrument of flexibility in the post-financial crisis regulatory framework that allows solvent but undercapitalized banks to receive capital aids under strict conditions, including the temporary nature of the aid. However, this instrument confronts a credibility issue as the public ownership of financial institutions persists several years after the use of precautionary recapitalizations. We analyze the legal and economic reasons that make the temporary nature of precautionary recapitalizations de facto unenforceable, proposing an analytical framework to approach the matter. In so doing, we challenge the consensus approach to the design of public interventions in banking, which focuses on the trade-offs between minimizing ex-ante moral hazard of bankers, preserving financial stability, and protecting taxpayers. We show that this approach is incomplete as it overlooks the ex-post effects of the intervention, jeopardizing its ex-ante credibility as well. Against this backdrop, we examine the implementation of precautionary recapitalization in the cases of National Bank of Greece, Piraeus Bank, and Monte dei Paschi di Siena. The analysis identifies the key factors undermining the temporary nature of the recapitalizations; specifically, the assessment of the bank’s solvency, the timing of recapitalization, the type of instruments employed, and the political economy of the recapitalization process. Finally, we briefly confront our findings with the Commission’s Crisis Management and Deposit Insurance (CMDI) proposal. We show that the CMDI wants to address the symptoms rather than the causes when reforming precautionary recapitalization, proposing an overly rigid system that is prone to abuses and political distortions.