Document Type

Working Paper

Publication Date

2017

Abstract

To try to protect the stability of the financial system, regulators and policymakers have been extending bankruptcy-resolution techniques beyond their normal boundaries. To date, however, their efforts have been insufficient, in part because bankruptcy law traditionally has microprudential goals (to protect individual firms) whereas protecting financial stability is a “macroprudential” goal.

This Article seeks to derive a logical and consistent theory of how and why resolution-based regulation can help to stabilize the financial system. To that end, the Article identifies three possible regulatory approaches: reactive resolution-based regulation, which comprises variations on traditional bankruptcy; proactive resolution-based regulation, which consists of pre-planned enhancements that are designed to strengthen or facilitate the resolvability of financial system elements that become troubled; and counteractive regulation, which seeks to reduce the need for resolution (and thus is not truly resolution).

The Article then argues that resolution-based regulation should seek not merely (as currently conceived) to protect individual troubled systemically important firms but also to protect against the failure of systemically important firms in the aggregate as well as to protect other critical elements of the financial system. These include the markets in which securities and other financial assets are traded and the infrastructure that serves to facilitate that trading. Finally, the Article applies these insights to design resolution-based regulation that can be used by regulators as an additional macroprudential “tool.”

Library of Congress Subject Headings

Financial risk management, Financial institutions--Law and legislation, Financial crises--Prevention

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