Too Big to Bail Out?

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Is your financial institution systemically important?

Chances are that even many financial services professionals aren’t familiar with that phrase, but they soon will be. That’s because, according to the Financial Stability Board (FSB), corporations in this hallowed category are so integral to the international financial system that, if they go under, it could potentially affect large swaths of the global economy. In other words, they’ve been deemed too big to fail (and yes, we’re all very familiar with that phrase), and that’s why they were fortunate to received taxpayer-funded bailouts. And while at least some of those funds have been returned, many taxpayers are still understandably seething.

So now we have the FSB, the international body that monitors and makes recommendations about the global financial system, stepping forward with a ‘Consultative Document’ playfully titled “Adequacy of loss-absorbing capacity of global systemically important banks in resolution.”

Dryness aside, this is a big deal. The stated goal of the new recommendations is to prevent taxpayer bailouts of large banks, specifically by doubling the cash cushion they would be required to have for rainy days. That refers to the perfect storm that drenched the entire system faced in 2008, and the occasional downpours specific institutions have faced since then.

The proposal is a “watershed in ending ‘too big to fail’ for banks,” said Mark Carney, FSB chairman and governor of the Bank of England. It is a designed to enable “globally systemic banks to be resolved without recourse to public subsidy and without disruption to the wider financial system.”

Of course, to get to that happy place, there will have to be some serious restructuring, and that in turn carries a high price tag.  In Europe, it means certain banks—think Deutsche Bank and BNP Paribas—will have to sell off many junior bonds and/or discard some risky strategies. It’s hard to conceive any scenario in which these recommendations are put into effect without drastically changing the way many of these institutions do business.

The new rules don’t come as a surprise—they’ve been generating buzz for weeks, and were required by G20 mandates to be put forth by the end of the year. More to the point, U.S. regulators have already put in place similar strictures for the eight largest (you might say systemically important) banks.

Of course, it’s not like any of this is going to happen right away. Even the U.S. regulations don’t go into effect until 2018, and the new FSB proposal is essentially the start of a lengthy debate. All interested parties have until early February to file an initial response, and the industry is clearly gearing up to fight the proposed new rules.

Their argument will clearly be that such draconian measures will hamper lending, which is turn will have a crippling effect on the larger economy. (For the record, banks in emerging markets are at least initially exempt from the new rules.) Besides, FSB proposals are not binding on any particular nation—technically, banks can keep doing what they do without running afoul of international law.

But in this operating environment, that’s not in any way feasible. There is enormous pressure on these massive enterprises, and on the governments that oversee them, to make drastic changes that prevent calamities of the kind that need taxpayer-funded bailouts. Many institutions have already changed their practices to reduce risk, and they’ve done it without cutting off the financial oxygen their customers need. It would be nice if the industry as a whole was perceived to be similarly sensible.

Written by Jack Dougal

Jack Dougal

Jack Dougal is's resident news reporter. He writes regular blogs covering the latest stories and key developments in the global financial services industry.

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