Steven L. Schwarcz is the Stanley A. Star Professor of Law & Business at Duke University School of Law and Senior Fellow at the Centre for International Governance Innovation. This post is based on his recent paper.
Since the financial crisis, regulators have been shifting their focus from traditional microprudential regulation, which protects individual banks and other financial firms , to “macroprudential” regulation that protects the stability of the financial system itself. Regulators have begun expanding that macroprudential focus to include bankruptcy “resolution” techniques designed to reorganize the capital structure of, or else to liquidate with minimal systemic impact, systemically important firms that become financially troubled.
To date, however, regulatory efforts to use those techniques to try to protect financial stability have been inadequate, in part because bankruptcy law traditionally has microprudential goals—to protect individual firms that are financially troubled but otherwise viable—whereas protecting financial stability is a macroprudential goal. Much of the current thinking about using bankruptcy-resolution techniques conflates these goals. This paper seeks to analyze the macroprudential goals of resolution, in order to differentiate them from microprudential goals and derive a logically consistent theory of how and why macroprudential “resolution-based regulation” can help to stabilize the financial system.