13 May 2014

BoE/Cunliffe: Ending 'too big to fail' – Progress and remaining issues

He spoke on the two-pronged approach taken by regulators: first, to reduce, but not eliminate, the probability of failure by increasing the resilience of financial institutions; second, managing the impact of failure via the resolution framework and by making investors bear losses.

Sir Jon Cunliffe explained that while much has been done to make the financial system more resilient, two key elements of the regime that is needed to reduce the likelihood of failure are still in the design and agreement stage. One of these is an international standard on leverage. Following agreement on a definition of the leverage ratio earlier this year, standard setters will decide on the calculation of a minimum standard in 2017.

As requested by the Chancellor last November, the FPC is reviewing whether a leverage ratio framework should be introduced in the UK in advance of the international framework. "This could include a power for the FPC to vary the ratio to counter macro-prudential risks. The FPC will consult on the review and expects to publish its conclusions towards the end of the year", he noted.

A second element of the capital and liquidity regime to be agreed is a standard for the Net Stable Funding Ratio to address banks’ long-term liquidity risks, due to be agreed by the Basel Committee in September. He acknowledged concerns in the industry that these two elements could have potentially serious and unwelcome unintended consequences on market liquidity, and says authorities are already looking closely at them.

He explained that tighter regulation may make it harder for dealers to absorb inventory when end investors wish to offload assets; meaning that market liquidity may start to fall away at an earlier point. He explained that reforms are also underway to reduce the impact of failure, and, specifically, to allow even the largest firms to fail and be resolved in a safe way without recourse to taxpayer funds.

Whilst the legal framework for resolving failed institutions is now in place, banks also need to hold sufficient debt that can be quickly bailed in if needed, also known as Gone Concern Loss Absorbing Capacity (GLAC). He noted that agreement on the objective of an international GLAC standard has been reached, and talks have now moved on to the key design features, such as the size of a GLAC requirement, the type of debt and where it should be located, as well as which critical economic functions need to be protected in the event of resolution.

Sir Jon Cunliffe observed that in order for resolution to be effective, derivatives contracts will need to be amended in order to prevent a scenario where counterparties in another jurisdiction of a firm had had been put into resolution could close out their contracts and seize collateral covering their replacement value.

Finally, he talked about a third important element of the TBTF agenda - structural reform. He points out that reform measures set out by the ICB in the UK, Dodd-Frank in the US and in the EU generally complement the resolution agenda by making it easier for the resolution authority to protect continuity in critical economic functions. However, work will be needed to ensure that implementation works with the grain of the resolution agenda, and that the application of different structural measures in different jurisdictions form a coherent package for the group as a whole.

Full press release 

Full speech

Further reporting by Reuters

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