In the aftermath of the financial crisis, governments are rightly reducing their exposure to the banking system. Bail-in arrangements should ensure that shareholders and creditors take the first losses. The next line of defence is a resolution fund, which is filled via levies on banks. Nevertheless, we argue that a fiscal backstop remains necessary for a banking system, as private arrangements may not be sufficient in a severe crisis. Without a credible backstop, depositors will run on a troubled banking system causing a bad equilibrium with a full breakdown of the banking system. Only the government can provide such a credible backstop.
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