US and UK plan to end too big to fail this year
THE UK and US now expect large banks to have resolution plans or “living wills” in place by the end of this year – despite a delay caused by the EU – which they hope will prevent taxpayers from having to bail out a failing bank ever again.
The FSA said yesterday that its publication of final rules for how a “too big to fail” bank should construct a living will had been delayed by Brussels’ decision to push back its equivalent framework, because the UK does not want to create confusion by having two parallel systems.
The City watchdog has now outlined roughly how the system will work and said that banks will have to have plans in place by autumn, despite the EU being likely to take until well into 2013 to craft its rules. The US has said very large banks will also have to have their plans in place by July.
A key part of the FSA’s living will system involves forcing investors who own banks’ debt to absorb losses by “bailing in” their bonds – turning them into equity or wiping them out.
The acting chairman of US regulator the FDIC Martin Gruenberg said yesterday that the US system will work similarly. In order to recapitalise the bad parts of a failed bank, he said: “The FDIC expects that it will have to look to subordinated debt or even senior unsecured debt claims as the immediate source of capital.” Senior bondholders, whose claim as a creditor of a bank was formerly seen as sacrosanct, will now get wiped out if the bank has huge losses.
Gruenberg said that the change “is designed to ensure that there is market accountability”, so that bondholders will now have more of an incentive to curb excessive risk-taking.
EU officials have been wary of unveiling rules on “bail-in” bonds because they worry it will create panic in debt markets, worsening the euro crisis.
But one senior debt capital markets banker told City A.M. that bond markets have moved on significantly from last year and are now trying to price in this extra risk. He said greater clarity from the EU will help, not hinder.
In addition to bail-in bonds, the FSA said that a key part of the process will be making sure banks have information on hand showing how different parts of the bank are exposed to one another and to other banks.
The problem of banks that are “too big to fail” means that if a large lender becomes insolvent, the instability caused by its collapse is deemed to be too severe to risk. Instead, such banks are bailed out using public money, a problem that regulators and banks are now trying to fix.