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G28 – Government Policy and Regulation

When an operating subsidiary is unable to repay or roll over its short-term debt at date 1, short-term creditors run on the bank’s short-term liabilities and the bank is liquidated at date |$1$|⁠.9 We assume that liquidation is inefficient, in the sense that the liquidation payoff |$L$| is strictly smaller than the market’s expected value of the banking franchise, |$L<\overline{p}_{2}V$|⁠.

Finally, we model the (potential) benefits arising from global banking activity by assuming that the continuation value |$V$| is contingent on the two subsidiaries continuing to operate within the same global bank after date |$1$|⁠. If the two subsidiaries are separated at date |$1$| (e.g., because national regulators invoke separate resolution procedures or when one of the two subsidiaries is liquidated), this reduces the continuation value to |$\lambda V$|⁠, where |$\lambda \leq 1$|⁠. This assumption captures the loss of economies of scale and scope that results from the breakup of the global bank. For example, separation of the subsidiaries eliminates efficiency gains arising from joint cash management, common IT systems, and other shared services.1If the operating subsidiaries want to prevent the reduction in continuation value that results from splitting up the global bank at date |$1$|⁠, they can do so by setting up redundant systems ex ante (e.g., by making sure that each operating subsidiary has its own independent cash management system). Redundant systems require a higher setup cost |$\widetilde{F}>F$|⁠. However, when a split-up of the global bank is sufficiently likely, it may be more efficient to incur this higher setup cost than lose economies of scope ex post. A key implication of this assumption is that it generates an interaction between the resolution model and the global bank’s operational structure: SPOE may be better suited to a G-SIB without redundant systems and with large economies of scale and scope, while MPOE may be more appropriate for a G-SIB with redundant systems in place