Why bank reform is all in the detail

Allister Heath
BAIL-INS, not bailouts: that ought to be the motto of any banking reformer worthy of the name – it will be interesting to see how much space is devoted to the concept in today’s report by the Independent Commission on Banking (ICB) (the document will include lots of good ideas, and also some rather silly ones). The idea of a bail-in is that if a bank hits the rocks, rather than phoning up the taxpayer for more equity capital, the bank automatically converts a chunk of its liabilities into new equity. This recapitalises it and allows it either to bounce back – or creates time for it to be wound-down in an orderly manner.

If such a system were in place, Barclays, RBS, Lloyds, HSBC and a host of global firm such as Credit Suisse, Deutsche Bank, JP Morgan and BNP Paribas could all easily withstand losing £40bn (the biggest one-year loss inflicted on a single institution during the crisis) without any taxpayer assistance. In fact, all of these could bear much larger losses. The entire economic and financial history of the past few years would be dramatically different had countries stopped protecting creditors and made bail-ins the norm, or acted fast and enforced one as things went bad in 2008. Taxpayers would have stood protected and real market discipline reestablished.

As part of its submission to the ICB, Barclays calculated that it had a loss absorption capacity for the purpose of a bail-in worth 47.6 per cent of risk-weighted assets in 2010 – senior unsecured debt, but also Tier 2 and Tier 1 capital on top of the Core Tier 1. Under a £40bn hit and an equivalent bail-in, its loss absorption capacity would fall – but to a still extremely comfortable 37.4 per cent. Of course, other reforms are needed too – not least new resolution procedures for large banks for whom bail-ins aren’t enough, as traditional bankruptcy procedures don’t work for systemic banks.

Yet it is a little-know fact that since the 2009 Banking Act the UK already has a special resolution regime in place. This already gives the authorities to power to dismantle and resolve failed banks, selling off good bits, shutting bad bits and protecting depositors and the payments system. But the big institutions and the FSA are still hammering out the details – and what banks need to do to reorganise themselves and provide data to make the process work efficiently. Six banks, including Barclays, HSBC, Lloyds and RBS, have submitted living wills under a pilot programme.

The aim is for the new resolution and recovery policy to be finalised during the first quarter of 2012 – but it will take a bit more time for everything to be operational. Eventually, the whole industry will have a Plan B if catastrophe hits, and the taxpayer will be protected, something that was scandalously lacking last time. The real pity is that none of this will be in place as the Eurozone crisis escalates. An excellent treatment can be found in Recovery and Resolution Plans, an FSA consultation paper out last month. The Financial Stability Board’s Effective Resolution of Systemically Important Financial Institutions is also interesting.

The UK is now ahead of other countries when it comes to building a resolution system and reintroducing profit and loss discipline to banking. Today’s headlines will be grabbed by the ICB’s ring-fencing proposals – but it would be a tragedy were they to inadvertently derail the plan to reintroduce real capitalism into banking.

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