WHAT’S IN A LIVING WILL?
■ The problem of banks being “too big to fail” refers to the failure of systemically important banks like RBS and HBOS whose collapse could destroy large parts of the financial system. Instead of going bust, they are bailed out, creating moral hazard.
■ The key tool regulators will use to solve the problem is to “bail in” debtholders of these banks. In the 2008 crisis, senior bondholders did not take losses because their legal rights as creditors were supreme.
■ Now, bondholders will have to price the risk of taking losses. But there are still key unknowns: what will trigger a bail in and how will the regulator share out the losses? Will bailing in be done differently depending on which bond an investor has or will it be done by legislation that effectively adds the same clause to every bond? And how will regulators mitigate the risk of losses spreading through the debt markets and destabilising other parts of the financial system?
■ One key tool will be having the right information on hand. This could take the form of a matrix that details the exposure different parts of a bank have to one another and to other banks, via loans, derivatives, investments and so on. This will help to split a bank quickly into its solvent and insolvent parts to provide temporary liquidity to the former. The systemically “essential” parts also need to be identified and supported.
■ Another tool will be “war-gaming”, where regulators and bank risk officers do “fire drills” where they try to resolve a bank.