Preventing German Bank Failures: Federalism and decisions to save troubled banks

Abstract

We examine government decisions to support troubled banks. Our contribution is the examination of how federalism can affect decisions to classify banks as systemically important. Whether a bank is viewed by politicians as 'systemically important' varies based on how its failure would affect supporters of the government. How a federation is designed has a strong influence on which banks are given public assistance. Where the top level of government is solely responsible for banks, there will be fewer systemically important institutions and so more banks will be allowed to fail. Where lower levels are responsible, governments will allow fewer failures. We use this approach to understand government support for failing banks in Germany. Our findings are relevant for the European Banking Union.