20 May 2013

BoE/Tucker: Resolution and future of finance

Tucker explained how resolution is essential to solving the problem of Too Big to Fail: “...if you believe in an international financial system that is not only free but also safe, in shielding taxpayers from the risks in banking, and in shielding banking from politics, you will be committed to making a success of resolution”. Absent effective resolution regimes, capital requirements for systemically important financial institutions (SIFIs) would be “considerably” higher, “supplemented no doubt by more radical restructuring of banking than planned to date by any of the major countries”. He says that, personally, he doubts that that alternative route would work in the end. “In short, there is no alternative to submitting banking and its investors to the disciplines of capitalism – failure as well as success. We cannot afford to have banking, so central to the allocation of capital in market economies, semi-socialised.”

If progress has not been faster, Tucker said it was because the required reforms affect property rights. “In democracies, that is rightly debated thoroughly to ensure that it has legitimacy and is subject to the right checks and balances”. He noted that all the jurisdictions of the G20 are committed to incorporating the Financial Stability Board’s (FSB’s) Key Attributes for Resolution in to their domestic legislation. “The US has largely done so. The EU is very close to doing so, through the Recovery and Resolution Directive. Switzerland has largely done so. Between them, this will account for the home countries of 24 of the 28 globally systemic banks listed by the FSB and the Basel Supervisors Committee last year.” 

Tucker set out the further steps required to ensure these resolution strategies can be implemented. First, he said, the authorities are going to need to decide how much loss-absorbing debt SIFIs need to have in issue. In Europe, he says, the draft resolution directive provides a framework. “...a global discussion is needed on this...my own provisional view is that the minimum for bonded debt might need to be equivalent to the sum of the firm’s regulatory equity requirement plus a margin (X) less any surplus equity. That would mean that bailing could be used to cover losses beyond a firm’s required equity base up to an amount X and then to recapitalise back to the ab initio equity standard.”

Second, Tucker highlighted the need to ensure that the imposition of losses on creditors does not itself cause systemic distress through contagion. Most obviously, he said, regulators must ensure that banks do not have material holdings of each other’s bonds and that insurance companies do not have concentrated exposures to banks’ bonds.

Third, in terms of group structure, Tucker said that it would be apparent that, even once the statutory resolution regime is in place, “...many financial groups are going to need to restructure themselves in order to achieve resolvability – financially, legally, organisationally...These will be bespoke restructurings – and will be on top of the plans for systematic structural reforms of banking around the world (Vickers, Volcker, Liikanen, and so on).”

Fourth, there is need for clarity about where different types of creditor stand. The big issue, he says, is about uninsured deposits: should they rank alongside senior unsecured bonds or should they be preferred? On the substance of the issue, he says he can “...see a case for both insured and some uninsured depositors being preferred. That would help to provide some protection, beyond the DGS, for users of the monetary services that banks provide via overnight and short-term deposits; it could provide a small degree of protection against runs; and there could be an element of social justice in insulating, say, small firms and charities from the first line of loss”. 

The most important next step though is to complete the implementation of the necessary legislation, with the EU resolution directive absolutely crucial. He highlights that it is unlikely that in future decades the West will account for such a large share of the unequivocally systemic firms and says that not a few emerging market countries are watching progress in the EU. “Indeed, it is not an exaggeration to say that the EU’s Directive is the keystone to breaking the back of the TBTF problem.” 

Full speech

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