Banks are never too-big-to-fail: IIF

An institution is never too-big-to-fail, and one of the dangers of adopting this mentality is the loss of consumer confidence in the resiliency of their banks.

When a recession hits, they’ll wonder if banks can truly survive, and if their tax dollar will be called on to help pick up the pieces of fallen institutions. And as the recession has continued, investors and clients are indeed showing signs of wariness and a lack of trust.

Read: Trust in financial industry declines

“One of the most important lessons of the financial crisis was that banks must be able to take risks, must be able to fail, and therefore must be capable of being resolved upon failure,” says said Douglas Flint, chairman of the board of directors of the Institute of International Finance (IIF). Today, the IIF released a report on the effective cross-border resolution of financial institutions.

Flint says confidence in financial systems will be enhanced when the public is convinced of two key conditions: “first, that major banks that get into difficulties can be put through an orderly, internationally coordinated process to resolve their insolvency or illiquidity without creating destabilizing systemic shocks, like Lehman Brothers did in 2008; second, that resolution does not require cash from taxpayers and that their funds won’t be needed to finance bail-outs.”

Read: Were Canada’s banks bailed out?

In the group’s report, the IIF calls on the Financial Stability Board to ensure that each major jurisdiction’s own national legal framework fully complies with its Key Attributes of Effective Resolution Regimes for Financial Institution.

“The FSB should strengthen its approach to secure effective cross-border resolution of major firms,” says Urs Rohner, chairman of the IIF working group on Cross-Border Resolution and chairman of Credit Suisse AG.

He adds, “The FSB ishould mandate – not just urge – effective cooperation among jurisdictions on cross-border resolution.”

Peter Sands, Chairman of the IIF special committee on effective regulation and group chief executive of Standard Chartered PLC., says “The development of coordinated bail-in is a useful and powerful resolution strategy that can align the incentives of national regulators and support the effective resolution of cross-border groups.”

He adds, “We propose a convention that could set guidelines and create well-understood expectations for how to handle the resolution [of a crisis].”

The IIF report emphasizes the need for both regulatory and supervisory authorities to see the economic value of financial groups in the global economy. Rather than financial groups being structured for a potential failure, the business economics of each group should be considered and resolution structures built. The IIF supports the call for a suite of resolution tools for all national authorities, including bail-in and other techniques to spread losses appropriately.

IIF managing director Charles Dallara says, “It’s necessary to assure fair and equal treatment for all creditors of a failing firm. Treating all creditors fairly means respecting the traditional hierarchy of claims.”

But, it also means recovering as much value as possible for creditors—especially those who get bailed-in. Fairness and the best possible outcome can be assured based on a “no creditor worse off than in liquidation” standard.

Sands says, “Effective cross border resolution plans, backed up with whole bank resolution techniques and a robust mandate for international cooperation, represent a compelling way to address the ‘too big to fail’ issue.”

The report includes a discussion of investors’ perspectives, stressing the need for fair, transparent and predictable resolution, especially across borders. If achieved, institutional investors, including pension funds and insurance companies, may be willing to purchase capital markets instruments of financial institutions at reasonable prices.

Read: Volcker on new CFA risk council