ABSTRACT
Financial institutions notably – but not exclusively – banks provide a wide range of financial infrastructure services. These include the processing of payments and the provision of credit and liquidity. Given their special role for the economy, their disorderly failure tends to give rise to the materialization of systemic risk. This causes major disruption. In the past, the availability of government bailouts addressed the problem of contagion but it engendered moral hazard and encouraged financial firms to take more excessive risks at the taxpayer's expense. Conversely, the application of ordinary insolvency law did little to stop the spread of contagion in the financial system. Recently, a special recovery and resolution regime has been offered as a third and arguably superior solution. This works in two ways. On the one hand, it implements measures that internalize the cost of systemic risk (although the need for public funding is not entirely precluded) while, on the other hand, it seeks to lead the distressed financial institution into recovery or – where this is not possible – into its orderly resolution.
