05 December 2013

Reuters: Regulators' emphasis on resolution plans may be misplaced

Focusing on too-big-to-fail policies and hard-to-implement resolution plans may lead regulators to miss the next big financial failure, which could come in the areas of shadow banking and short-term financing, industry experts said.

This was the main message given by a panel of experts at a conference organised by the Clearing House, a banking association and payments company.

By putting too much emphasis on the too-big-to-fail issue, and breaking up big banks through tools such as the Volcker rule ban on proprietary trading, regulators have, until recently, largely ignored the risks posed elsewhere in the financial system, Glenn Hubbard, former chairman of the White House Council of Economic Advisers and a professor at Columbia Business School.

Another panellist, Andrew Metrick, Professor at Yale School of Management, cited the New York Federal Reserve’s definition of shadow banking as any legal financial activity that falls outside the government safety net and without access to a liquidity facility. In examining how these institutions outside the traditional purview of regulations changed over the years, he pointed out that at each stage, their credibility suffered due to the lack of a backstop mechanism, such as deposit insurance or discount lending. Metrick said the regulators should focus not on institutions per se, but the functions, as they are more likely to indicate where the next crisis may lay.

Professor Richard Herring, of the University of Pennsylvania, noted controversial aspects of resolution plans and living wills, which aim to provide roadmaps in unwinding failed financial institutions while containing its spill-over effects into the wider economy. The single-point-of-entry (SPE) resolution system now gaining regulatory interest, with its focus on applying resolution at the holding-company level of a firm, is at odds with separate requirements by US bank regulators that financial institutions provide living wills for individual subsidiaries.

Cross-border harmonisation of resolution plan regulation would be impossible, he said, despite the efforts by the FDIC and the Federal Reserve to establish consultative networks, most notably with the Bank of England, BaFin in Germany, and FINMA in Switzerland. Inter-agency political battles among various regulatory bodies in the United States could provide a microcosm of the difficulties that may surface in the next crisis when each jurisdiction would look after its best interests.

Peter Fisher, a Senior Managing Director at BlackRock, said different margin requirements on derivatives contracts may be in place for two equally resolvable institutions because of their different risk profiles. The underlying assumption is that a failed institution’s side of the bargain would be honored by the clearinghouse. "The fact of the matter is, at the end of the day, if an institution is resolvable, I don’t see what incentive the counterparty would have in demanding any margin or collateral?", he asked.

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