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date: 11 April 2021

Abstract and Keywords

With the introduction of Basel II in 2004, “market discipline” became one of the Basel Committee’s three pillars of prudential regulation. Although many academic papers have sought to test for the presence of effective market discipline in banking, few have dealt fully with the question. Effective market discipline involves two distinct steps: monitoring a bank’s condition and influencing it to avoid unacceptably large risks. Both phases of market discipline are necessary; neither one alone sufficient. In this chapter, we provide a careful definition of market discipline, explain how it may complement supervisory efforts to control an institution’s risk-taking, and review the available literature on the efficacy of market discipline. We also discuss how recent changes in supervisory actions toward failing banks has changed the channels through which market discipline will work going forward.

Keywords: bank failure resolution, Bank Recovery and Resolution Directive, Dodd–Frank, financial regulation, market discipline, Total Loss Absorbing Capacity

Mark J. Flannery

Mark J. Flannery has been the BankAmerica Eminent Scholar in Finance at the University of Florida since 1989. He previously held faculty positions at the University of North Carolina (Chapel Hill) and the University of Pennsylvania. He has published extensively, particularly in the areas of corporate finance and financial regulation. He holds economics degrees from Princeton (A.B.) and Yale (M.A., M.Phil, and Ph.D). He served as president of the Financial Intermediation Research Society (FIRS), president and board chairman of the Financial Management Association, and member of the board of directors of the American Finance Association. He was an editor of the Journal of Money, Credit and Banking from 2000–5.

Robert R. Bliss

Robert R. Bliss is Professor Emeritus of Finance at Wake Forest University, where he taught courses in derivatives, fixed income, and capital markets. Prior to returning to academia in 2014, he served as a senior financial economist at Federal Reserve Bank of Chicago and held research positions at the Bank of England and the Federal Reserve Bank of Atlanta. Previously, he taught finance at Indiana University. His research interests include fixed income securities and derivatives, structured finance, risk management, financial regulation, and the law and economics of insolvency. He earned his doctorate in finance from the University of Chicago.

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