Whether it is liquidation or resolution that beckons makes a difference, as resolution can materially reduce both the private and social costs of bankruptcy. Relative to a world in which liquidation is a credible threat, having an effective resolution regime will tend to reduce the cost of bond finance and so increase its share in the capital structure. But as explained earlier, it will tend to raise the cost of bonds and reduce their share in the capital structure relative to a state of affairs in which government bailouts are confidently expected. Effective  5  See Kashyap, Rajan and Stein (2002), “Banks as liquidity providers: an explanation for the coexistence of lending and deposit-taking”, Journal of Finance, vol, 57(1), pp. 33–73. 6  See Kashyap, Lamont and Stein (1994), “Credit Conditions and the Cyclical Behaviour of Inventories”, The Quarterly Journal of Economics, Vol 109, Issue 3 (Aug. 1994), P565–592. That bank failure itself has wider spillovers, through impaired credit availability, is itself another departure from Modigliani-Miller, which assumes that all households and firms have symmetric access to credit markets. 7  In addition, the management of the bank will find themselves out of a job. In contrast to the managers of failed firms in other sectors, they face regulatory hurdles to re-entering the industry. That provides a clear incentive to avoid a fragile capital structure. As widely discussed, that needs to be reinforced by remuneration packages that expose their wealth to downside risks. Agency issues internal to banks are not covered in my remarks today.

Paul Tucker: Banking reform and macroprudential regulation – implications for banks’ capital structure and credit conditions Speech by Mr Paul Tucker, Deputy Governor for Financial Stability at the Bank of England, Member of the Monetary Policy Committee, Member of the Financial Policy Committee and Member of the Prudential Regulation Authority Board, at the SUERF/Bank of Finland Conference, “Banking after regulatory reform – business as usual”, Helsinki, 13 June 2013. *  *  *  Many thanks for input and conversations to Steve Cecchetti and Anil Kashyap and, at the Bank, James Benford. For secretarial support, to Sandra Bannister, Alexandra Ellis and Vicky Purkiss. Although the current reform programme rightly extends to the capital markets – over-thecounter derivative markets, clearing houses and shadow banking for example – nevertheless banking is at its core. So today I am going to draw out some of the implications for the credit system – starting with the micro regulatory regime and banks’ capital structure; and then moving on to the introduction of new macroprudential policies and their effect on credit conditions. Micro regulatory reform and banks’ capital structure At a micro-level, the banking reforms have two important components. A step change in regulatory requirements on capital, leverage and liquidity, in order to reduce the probability of banks failing. And recognising that failure cannot and should not be ruled out, establishing credible and effective resolution regimes. Separately and in combination, they will change how the risks in banks’ portfolios are distributed across shareholders, bondholders, depositors and, perhaps most important, taxpayers.