Fiscal Burden Sharing in Cross-Border Banking Crises

This paper focuses on the recapitalization of failing banks. A recapitalization is efficient if the social benefits (preserving systemic stability) exceed the cost of recapitalization. In a national setting, the implementation of an optimal policy is relatively straightforward. But in a cross-border setting, one is confronted with possible coordination failure. Using a multi-country model, it is shown that ex post negotiations on burden sharing lead to an underprovision of recapitalizations. Next, we explore different ex ante burden-sharing mechanisms to overcome the coordination failure. The first is a general scheme financed collectively by the participating countries (generic burden sharing). The second relates the burden to the location of the assets of the bank to be recapitalized (specific burden sharing). The working of the two mechanisms is calibrated with data on large cross-border banks in Europe. Because the costs and benefits are better aligned in the specific scheme, it is better able to overcome the coordination failure.