Economic Consequences of Mandatory Bail-in

The European Union adopted bail-in provisions that require creditors to absorb losses either through write-down or conversion of debt to equity when banks are close to insolvency. I find negative shareholder reactions and positive creditor reactions to events associated with bail-in adoption. Further analysis shows that the positive creditor reactions are primarily driven by debt instruments that have higher priority ranking in the bail-in process. Exploiting the staggered transposition of the bail-in provisions into national law across member states, I find that banks experience a decrease in risk-taking subsequent to bail-in implementation. Collectively, these findings suggest that bail-in provisions lead to risk-reduction and mitigate shareholder-creditor conflicts. Further analyses show that banks are more likely to serve as lead arrangers, require collateral, and shift loan portfolio concentration to borrowers with prior lending relationships and lower growth opportunities. Overall, my paper provides policy implications for the economic consequence of bail-in provisions and highlights the importance of capital structure in bank risk-taking and lending behavior.