Resolution Mechanism
A resolution mechanism is a legal framework that manages the orderly restructuring or wind-down of failing banks.
Meaning in Practice
Resolution authorities intervene when a bank is deemed failing or likely to fail. Tools include bail-in, asset transfers, bridge banks, or temporary public control. The objective is to maintain critical functions while minimizing systemic disruption.
Why It Matters
Effective resolution mechanisms protect financial stability and reduce taxpayer exposure. They provide clarity on loss allocation and crisis management. This strengthens confidence in the banking system.
Market Impact
Clear resolution rules reduce uncertainty during bank distress and support risk pricing transparency. Investors adjust funding costs based on expected loss-sharing arrangements. Strong frameworks can limit contagion effects.
Example
When a bank becomes insolvent, authorities may transfer viable operations to a bridge institution while imposing losses on shareholders and certain creditors.