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Afghanistan’s banking sector strives for stability

Second, SPOE resolution may not be implementable ex post, even when agreed upon ex ante. When the cross-jurisdictional transfer required for a successful SPOE resolution is too large, regulators may prefer to ring-fence assets in their own jurisdiction, thereby preventing the required transfers. The planned SPOE resolution breaks down, leading to a disorderly liquidation or a tax-funded bailout. We show that the possibility of such an ex post breakdown of a planned SPOE resolution depends on the risk profile and operational structure of the financial institution at hand. In particular, incentive-compatible SPOE resolution requires operational complementarities across national banking operations, such as those arising from joint cash management or other shared services. The prospect of losing these complementarities incentivizes regulators not to ring-fence assets ex post.

When SPOE resolution is not ex post incentive compatible, MPOE resolution, where loss-absorbing capital is held by national holding companies in each jurisdiction, can still support a successful resolution. MPOE resolution eliminates some of the diversification benefits that would be achievable under SPOE, but the absence of cross-jurisdictional transfers implies that MPOE is not subject to ex post incentive compatibility constraints. Accordingly, ex post incentive compatibility generates a link between bank structure and the appropriate resolution model. In particular, for global banks with more decentralized operations and larger required transfers during resolution, a more robust MPOE resolution model is appropriate. More generally, we show that the constrained optimal resolution mechanism in this situation follows a hybrid approach, where an appropriate amount of loss-absorbing capital is preassigned to particular jurisdictions, thereby restoring incentive compatibility while preserving some benefits of resource sharing in resolution. These results shed light on recent proposals for the prepositioning of “internal TLAC” within G-SIBs.