This study investigates the link between bankruptcy and security legislation and potential credit losses faced by banks based on a cross-country study for the United States (US), the United Kingdom (UK) and Germany. Focusing on corporate credit, we find that legislation produces the highest credit risk in the US, followed by Germany, while UK law is found to be most favorable for banks. US banks gain from the higher number of informal restructurings (without losses) but lose from the low level of recovery in formal proceedings. German banks demand more credit risk mitigates than UK and US banks do, but still recover less than do UK banks. To be at par with UK banks, US banks would have to recover more than twice as much in formal proceedings, while German proceedings would have to be shortened by about one half. Previous studies have shown that differences in corporate bankruptcy codes matter (a) for banks that may suffer higher losses as well as for financial stability if losses accumulate; and (b) for economic growth, as some codes can help keep businesses alive while others would not. With the globalization of economic activity3, differences in codes, which are often deeply rooted in cultures and traditions, were subject to enforced scrutiny.
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| Document Type | General |
| Publish Date | 11/03/2011 |
| Author | |
| Published By | International Monetary Fund |
| Edited By | Tabassum Rahmani |
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The Impact of Legislation on Credit Risk
In a study comparing Sweden and the US, for example, Thorburn (2000) found that the Swedish system is faster and cheaper than the US Chapter 11 process, which results triggered lively discussions in the US; in 2005 legislation was changed in favor of creditors. In Europe, it was discussed whether the stigma of bankruptcy, which is particularly strong in continental Europe, would have negative effects on growth as it restrains the second chance for entrepreneurs. As part of the Lisbon Growth and Jobs Strategy, the European Commission (EC) sought to reduce the stigmatization of business failures to promote entrepreneurship.4Ultimately, the policy decision is not only to investigate whether the proceedings can be more efficient (while maintaining a system that remains fair in terms of the interests of all stakeholders involved in the proceedings), but to decide how creditor- or debtor-friendly legislations should be. This study focuses on the financial stability dimension. To this end, it deals with the implications on the credit riskiness of corporate loans evolving from differences in national legislations for corporate bankruptcy and secured transactions. The focus is on potential credit losses faced by banks (usually senior creditors), seeking to minimize credit losses. As such, we leave other important complementary aspects aside, particularly whether and how.