The Economic Impact of Insolvency Law

Abstract

Dissatisfaction with the current system for handling bank insolvencies has led Mayes, Halme and Liuksila (2001) (henceforth MHL) to propose a range of reforms. These are put forward within the context of the situation as it currently applies in much of Europe, although MHL are also concerned about the handling of bank insolvencies internationally. These reforms are intended to eliminate the costs and risks that the taxpayer might otherwise incur in the event of bank insolvency, the moral hazard that ‘always attaches to extending state aid to insolvent banks’ and the ‘undue delay’ that causes losses of bank assets in reorganizations. The essence of the MHL proposals is to empower a government agency to seize control of an insolvent bank and effectively allow it to reduce the claims on the bank until the point at which it may be sold as a going concern or liquidated in an orderly manner.¹ In this way the judicial insolvency process is avoided, although the reduction of claims of insolvent banks will lead to losses for pre-existing shareholders and uninsured creditors in the same way as formal insolvency.

This chapter is published with the kind permission of the Bank of England, but the views expressed are those of the authors, not necessarily those of the Bank of England. We are grateful to conference participants, Bill Allen, Peter Brierley, Alastair Clark, Glenn Hoggarth, Geoffrey Wood and John Young for comments. They are not responsible for any remaining errors.