BIS Officials Propose Quick, Clean Method to Resolve 'Too-Big-To-Fail' Banks
By Dow Jones Business News, June 02, 2013, 03:14:00 PM EDT Vote up
By Geoffrey T. Smith
For the last four years, global regulators have fretted that they still haven't found a way to deal with a major banking collapse without asking taxpayers for yet more money to keep the financial system stable. But an article published by the Bank for International Settlements at the weekend suggests it may be much easier than thought.
The article, published in the BIS's quarterly report, lays out a scheme under which a large and complex bank could be resolved over the course of a weekend, in such a way that shareholders and creditors would bear the cost of the failure, and would know the maximum amount of their loss almost immediately, while taxpayers would be left unscathed.
Such a solution would be akin to a Holy Grail for banking regulators, who have found the issue of banks that are "too- big-to-fail" by far the most difficult part of the regulatory response to the 2008 financial crisis, triggered by the collapse of Lehman Brothers Inc. A report in April by the Financial Stability Board, which coordinates the global regulatory response to the financial crisis on behalf of the Group of 20 major industrial and emerging economies, concluded that there was still "substantial" disagreement internationally over what a resolution regime should look like, and said few of the world's major jurisdictions had the laws and institutions in place to deal with such a failure adequately.
The authors Paul Melaschenko and Noel Reynolds--both members of the secretariat of the Basel Committee for Banking Supervision--argue that their model would reconcile three principles that have so far seemed irreconcilable: first, that a resolution should respect the existing hierarchy of bank creditors; second, that it should limit the risks to financial stability and reduce value destruction in the remaining bank by creating immediate clarity over the scale and distribution of the losses required; third, to avoid discrimination and favor in the treatment of various forms of liabilities.
Their model essentially blends elements of the "Single Point of Entry" system of bank resolution embraced by the U.S. and UK, and the "Direct Bail-in" approach which focuses on quick recapitalization by the conversion of junior liabilities into equity.
The model suggests that, where the authorities have to resolve a failed bank, they transfer its business to a new holding company, and issue claims on the new company to shareholders and creditors, equal in rank and size to their previous claims.
These claims--the liabilities of the new holding company--would then be written down immediately to a degree where the authorities consider the new holding company to be well enough capitalized to cope with all expected losses. As equity is the difference between assets and liabilities, it automatically increases, the more the liabilities are written down.
The resolution authority would then seek buyers for the new bank, having replaced the old bank's management as it saw fit. Those with claims on the new bank would reimbursed from the proceeds of the eventual sale.
One plus point of the "creditor-funded" approach, the authors say, is that it would largely remove the need for banks to issue hybrid securities. These function as debt as long as the bank is viable, but convert into equity if a bank fails and needs to be resolved. Demand for such instruments has been mixed, as a large part of the universe of bond buyers either doesn't want or isn't allowed to act as the part-owner of a bank. That restricts the circle of potential buyers, and raises banks' funding costs. Under the BIS model, bond investors could hold bank debt knowing that, even in the event of a failure, they would receive debt instruments from the new bank instead of equity claims.
Similarly, Messrs. Melaschenko and Reynolds argue that their model avoids what they see as a key weakness of the Single Point of Entry approach, which they say aims too narrowly at writing down long-term debt, rather than all liabilities. Regulators in general have encouraged banks to make the structure of their liabilities more simple and more long-term, but SPoE tends to have the reverse effect.
"The downside of such approaches is that the creditor hierarchy is not respected and the most complex and shortest- duration senior claims are effectively subsidized by those that are less complex and longer in duration," the authors say. While the principles explained by the authors are clear enough, they do not claim to have found a simple solution for quickly valuing and ranking liabilities tied to derivatives, or to other complex structures, a problem likely to feature prominently in the resolution of any large and complex bank, especially one operating across many jurisdictions. They acknowledge that their plan could only be implemented successfully if the exact hierarchy of claims can be clearly articulated ahead of a failure.
Write to Geoffrey T. Smith at
geoffrey.smith@dowjones.comRead more:
http://www.nasdaq.com/article/bis-offic ... z2VG4uKlOK
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