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The Basel Committee has proposed a new capital framework to respond to the deficiencies of the 1988 Capital Accord (Basel I). The 1988 Accord has been criticised for its crude assessment of risk and for creating opportunities for regulatory arbitrage. In principle, the new approach, often referred to as Basel II, is not intended to raise or lower the overall level of regulatory capital currently held by banks, but to make it more risk sensitive. The spirit of the new Accord is to encourage the use of internal systems for measuring risks and allocating capital (the Accord extends the use of internal models from market risk to credit risk). A number of issues have been raised, however, with regard to its complexity, its cost, its impact on procyclicality, the possibility that it can lead to competitive distortions if some countries do not apply it (some big emerging economies) or apply it differently to small and big institutions (the USA) and others. Banks in Europe will also be obliged to comply with the new Capital Directive, often referred to as CAD III, which is the means by which the EU will implement the new Basel Capital Accord. CAD III will apply to all credit institutions and investment firms and not only to internationally active banks, as Basel does. This paper presents a critical approach to these developments and examines their impact upon the banking industry.

This paper discusses some of the lessons learnt from the use of the ‘bail‐out’ technique in the financial crises in Thailand, Korea and Indonesia in 1997–8. While the solution to debt crises in the past relied upon debt restructuring techniques which involved directly creditors and debtors, a distinct feature in the recent Asian financial crises, as well as in the Mexican crisis in 1994–5, is the massive amount of public funding — from bilateral and multilateral sources — that has been made available to shore up the crisis. The need for immediate disbursal of vast sums of money as well as the speed with which the crisis evolved, prompted governments to provide financing in a way that is reminiscent of the emergency liquidity assistance provided at a domestic level by the lender of last resort role of the central bank. By analogy to the bank‐to‐bank (micro) contagion that provides the theoretical rationale for the domestic lender of last resort, the country‐to‐country (macro) contagion and associated quick loss of confidence is the main argument put forth to justify the role assumed by the International Monetary Fund as de facto international lender of last resort in the late 1990s.

The purpose of this paper is to examine the complexities of reorganizing and/or liquidating troubled banks under the European Union's (EU) current institutional framework as it is defined by its directives and by national supervisory, remedial, and insolvency practices.

The paper compares provisions of different EU directives that impact financial institutions and summarizes national remedial practices.

The paper documents the diversity that currently exists among national supervisory, remedial and failure resolution practices for banks. It also assesses the economic efficiency of the institutional framework for resolving problem banks that is defined by the Reorganization and Winding‐up Directive and identifies components of the directive that can hamper efficient cross‐border resolutions.

There is a deficiency in publicly available information on EU member countries' practices for disciplining and resolving troubled banks.

The paper assesses issues/conditions that can hamper efficient cross‐border resolutions – issues on which policymakers should focus when they reform the current framework. It also explores areas of coordination with other EU directives that deal with financial crisis management that are relevant in the current financial crisis.

The paper makes policy recommendations for reforming the EU's current institutional framework for resolving troubled banks.