Talk about aiming high, Bank of England.
The central bank’s deputy governor for financial stability Paul Tucker has given a speech on Tuesday about the social responsibilities of the banking sector and associated reforms. The centrepiece: banks must prepare themselves for an “orderly wind-down” in case they fail.
Here’s an extract from the speech, which sums up the thrust of it pretty well:
. . . All three elements of the Social Contract for banking need to be reformed. Better regulation and supervision, including a macroprudential element. Better arrangements for liquidity insurance, which the Bank has tried to introduce alongside our international peers. And, my main topic today, a new regime for resolving bank distress. In particular, banks must structure and run themselves to permit orderly wind down. And they must invest to provide the authorities with the information they need to do so.
This will not be easy. And it will not be cheap. Together with higher capital and liquidity requirements — lower leverage and reduced maturity transformations — over time it may well mean a lower headline return on equity for some banks. But, of course, it would also entail lower risk for bank equity and bond investors, and surely it is risk-adjusted returns that matter. And it would also deliver lower risk to society more generally, which matters hugely.
Not easy or cheap indeed. In fact, according to Tucker that means making banks pony up for the deposit insurance provided by the Financial Services Compensation Scheme (something that’s already being trialled in the USA with FSCS’s counterpart, the Federal Deposit Insurance Corporation).
But crucially it also means making them provide information about their deposit base:
In the first place, it entails banks maintaining up-to-date information on their retail deposits in a way that facilitates rapid payout under the FSCS. Rapid payout is necessary to maintain the confidence of depositors in other banks. It’s all very well most retail depositors being 100% protected, but not so comforting if they had to wait ages to receive repayment from the deposit insurer after their bank had failed. . . . banks must invest in the information systems to be able to provide the FSCS pretty well instantly with what they need for rapid payout.
But the info is also needed in case the BoE in conjunction with the UK’s financial regulator (something of a power struggle here) decides to use its powers under the Special Resolution Regime for banks, which gives the FSA special abilities to try to save a failing bank, in effect seizing the bank’s assets:
. . . The information I outlined is not needed just when a bank does actually go into liquidation and the FSCS makes a payout to depositors. It is also needed by the Bank of England to assess whether any of the Special Resolution Regime (SRR) tools could meet the statutory objectives of the 2009 Act more effectively than liquidation. Indeed, that is why the Bank has a clear interest in the information provided to the FSCS.
In fact, even more information is needed when we employ the SRR instead of liquidation. Using the new Act, the Bank, working the FSA and HMT, can split up a bank or building society into a number of pieces: deposits going to one buyer; some assets possibly to another; parts going into administration. Effective execution of an operation of this kind is very information intensive. For example, it requires banks to have up-to-date, coherent management accounts for all parts of the business. One might think that would be a good idea anyway. It should certainly be a requirement now.
Execution also requires detailed information on how the business is run. Just a few examples. First, on the services that different parts of the group provide to each other, because if split up they may have to agree so-called Transitional Service Agreements. Second, on which essential services have been outsourced. Third, on details of netting and derivative contracts, so that the Bank can apply various statutory safeguards for creditors. That is a formidable task, and it is striking that, in the US, the FDIC has introduced a requirement that troubled banks must be able to demonstrate that, if necessary, they could report each day the details of so-called Qualifying Financial Contracts, which are essentially derivatives. We may need to contemplate something along those lines in the UK.
All of that is needed after buyers for the business have been found. Potential bidders for all or part of an ailing bank will themselves need the kinds of information typically offered to bidders in a ‘friendly’ M&A transaction. So there is a case for banks routinely maintaining such a Data Room as part of their crisis contingency plans. In delivering its resolution responsibilities under the 2009 Banking Act, the Bank is ready to work with banks and the FSA in helping to specify in more detail what is needed in practice. If the information can be ready almost routinely the execution of resolutions would be aided. . . .
To take the orderly wind-down idea even further, Tucker suggests banks could start preparing ‘wills’ on how they want their estates to be dismantled:
There is a broader issue lurking in the background here, and in today’s environment we can and must address it openly. Last Friday, in the Bank’s latest Financial Stability Report, we emphasised the importance going forward of enhancing market discipline, notably through much better disclosures. But proposals for greater market discipline are not going to gain traction in the real world — the only world that matters — so long as wholesale creditors and others believe and act on the basis that some firms can be Too Big To Fail. . . . We need to sort all that out one way or another. It is part of a wider debate about the future structure of the industry. The Bank is contributing to that debate, and a number of options 9 were discussed in our Financial Stability Report last week, including as the Governor said at the Mansion House a fortnight ago, whether or not banks’ activities should be regulated more heavily or even in the extreme restricted. That debate is obviously difficult, with no easy answers. But it is important, and cannot be ducked. As the Governor proposed at the Mansion House, it would help greatly if your banks could write a ‘will’ for how they could be wound down in an orderly way in the face of distress. Indeed, that now has to be part of the banking Social Contract.
Banks – here’s your (rather morbid) summer homework! :
Ten Steps to Completing Your Last Will and Testament
Related links:
A Special Resolution Regime for banks must put taxpayers before shareholders and bank creditors – Willem Buiter
King stirs row over teetering banks – FT
The Tripartite Memorandum of Mis-understanding – FT Alphaville
FDIC, the ‘F’ stands for… – FT Alphaville