Swiss bank UBS in Lugano, Switzerland: countries need to push ahead on their plans to deal with big global banks when they get into trouble (photo: Michael Buholzer/Reuters)
CROSS BORDER BANKS
As the collapse of U.S. investment bank Lehman Brothers in 2008 demonstrated, when one of these institutions is in trouble, the impact reverberates around the world.
The assets of some of the largest cross-border banking groups are several times their home country GDP. The largest banking groups typically have over half of their credit risk exposures and staff outside of their “home” country.
Policymakers have to agree on the legal and financial measures to ensure failures of big cross-border banks are managed in an orderly way. This will help minimize losses and protect global financial stability.
“These banks have a global reach and when they fail they have global consequences,” said Ceyla Pazarbasioglu, a deputy director in the IMF’s Monetary and Capital Markets Department, who with the Legal Department produced the report.
“We now have internationally agreed principles on the resolution of global banks and systemic institutions, and this is important progress, but we are not there yet. If a cross-border financial institution were to fail tomorrow, it would not be possible to resolve it in an orderly manner. What was agreed must be implemented in practice, and more work is needed to make sure that countries can—and have the incentives to—act cooperatively to resolve a failing cross-border bank,” said Pazarbasioglu, referring to the Financial Stability Board’s Key Attributes for Effective Resolution. Member countries have committed to implement the new rules by the end of 2015.
The euro area’s banking union is one recent example of progress toward more effective resolution of cross-border banks when they fail. In particular, the Bank Recovery and Resolution Directive, approved by the European Parliament in April 2014 will help ensure failed banks are resolved speedily, minimizing risks to financial stability and with losses borne by shareholders and creditors.
Fixing “too-big-to-fail”
Developing the strategy and tools for dealing with these big global banks is part of the solution to the “too-big-to-fail” problem. In a recent speech in London, the IMF’s Managing Director Christine Lagarde said taking further steps towards an effective framework for the resolution of cross-border banks is a top priority.
“This is a gaping hole in the financial architecture right now, and it calls for countries to put the global good of financial stability ahead of their parochial concerns,” said Lagarde.
In the wake of the global crisis, policymakers from finance ministries, central banks, and bank supervisory agencies agreed a set of principles and best practices to deal with the failure of big banks that operate across borders.
While some countries have made progress, overall three key areas need more work according to the report:
• Bail-in capacity of private creditors. To avoid the need for a bailout with public funds, big banks need to carry enough financial capacity to absorb the losses without damaging ripple effects on the financial system and the economy. Determining the nature, amount, and location of this debt within a bank’s structure is essential to ensuring that a bail-in is not just legally feasible, but also credible as a policy option.
• Creditor hierarchy. Countries have different rules that determine the order in which investors take a hit when a bank fails. Big differences in the creditor hierarchies between countries can cause problems in a cross-border bank failure, because losses for specific groups of investors would be different depending on whether home or host country rules applied.
• Use of taxpayer money to rescue banks. Since the global crisis, there is little appetite and less capacity to use public money to address the failure of a large bank. Regulatory reforms, including on resolution, aim to minimize the use of taxpayer money. But there will always be a risk that governments will need public money to protect financial stability in a crisis. Practical ways forward are mechanisms to monitor and minimize this risk on an ongoing basis, and to recover from the financial industry any public money used.
As part of its surveillance of financial stability, the IMF will assess the strength of countries’ frameworks for the orderly resolution of global banks.
The IMF issued its last review of progress on bank resolution in August 2012.
