RegTech Intelligence

Banks still pose the risk of being “too big to fail”

On 18 August 2016, the Financial Stability Board (FSB) published two final guidance papers for authorities and firms as part of the agenda to end the “too big to fail” risk.

Some progress is being made, and the FSB has said that “banks have begun to develop issuance strategies to meet new total loss-absorbing capacity requirements, and national regulators are working on implementation of the standard. Lenders are also putting in place arrangements to support operational continuity of critical shared services in resolution.”

However, key challenges remain regarding banks having insufficient liquidity to maintain critical operations in adverse market conditions. The purpose of these papers is to ensure that temporary funding is available for global systematically important banks (G-SIBs) without the need for a public bailout.

So … how is the FSB going to ensure that funding is available? The report says that jurisdictions should have policies in place so that authorities do not heavily rely on public bailouts to help distressed firms. It also says that jurisdictions should have privately financed funds in place to help provide the cost of temporary financing. The G-SIBs’ internal liquidity sources, such as cash and other liquid assets available for sale or collateral, should be used first to meet liabilities. To make up for any shortfall, the G-SIB should approach private markets before using the public sector backstop funding mechanism.

The report states “there is a risk of insufficient liquidity to maintain critical operations arising from the G-SIBs’ inability to roll over short-term borrowing or loss of access to alternative sources of credit.” In addition, a further understanding and analysis of funding and liquidity needs during adverse market conditions must be carried out – especially in regards to different currencies.

“We have come a long way in making resolution work in practice, and the effective implementation of the guidance papers released today will be another important step into this direction,” says Andrew Gracie, Chair of the FSB Cross-border Crisis Management Group for banks and Executive Director for Resolution at the Bank of England. “However, the RAP results for G-SIBs show that challenges remain in a number of important areas where we need to undertake renewed efforts during the remainder of the year and in 2017 to complete the job of ending ‘too-big-to-fail’.”

The list of the top 30 G-SIBs is maintained by the FSB and the Basel Committee on Banking Supervision (BCBS). It includes banks such as HSBC Holdings Plc., China Construction Bank Corp., RBS and J.P. Morgan Chase & Co.

The guidance paper addresses 6 key areas of issue:

  1. Private sources of funding – The first key area focuses on reducing temporary liquidity support from the public sector and minimising the risk of moral hazard. It states that G-SIBs should firstly rely on private funding before turning to the public sector.
  2. Public sector backstop funding mechanism – It also states that “an effective public sector backstop funding mechanism should be available for use when necessary and appropriate in order to promote market confidence and to encourage private sector counterparties to provide or to continue to provide funding.” It should be noted that the source of public sector funding will vary by jurisdiction.
  3. Strict conditions to minimise moral hazard risk – The report emphasises that public sector backstop mechanisms should only provide temporary funding if market access to funding is temporarily unavailable, to help foster financial stability, or be subject to strict conditions, for example, the terms of funding include conditions to minimise moral hazard risk. Minimising moral hazard risk is not only to address the agenda of banks being too big to fail but also to aid the FSB complete their systematically important financial institution (SIFI) reform agenda.
  4. Provisions to recover any losses incurred – If temporary funding is needed, the authority extending the temporary funding should make provisions to recover any losses incurred, either from shareholders, unsecured creditors or from the wider financial system.
  5. Establishing the soundness and feasibility of the resolution plan – The FSB also wants to restore market confidence and ensure “that the root causes of failure are being addressed.” It firmly believes that the existence of a well-developed and implementable resolution plan will be important in doing so and this will also reassure the public that the plans that have been put into place will be effective.
  6. Cross-border cooperation – In its final point of focus, the FSB wants cooperation between home and host authorities in order to provide support in the effective implementation of group-wide and local funding plans. This includes consistency in terms of information-sharing between home and host authorities.

The FSB has stressed that – only as a last resort – countries can place the firm under temporary public ownership and, in the meantime, arrange a permanent solution such as seeking a private purchaser for a sale or merger.

Several priorities are identified for the remainder of 2016 and 2017 to help complete the objective of ensuring that firms can be resolved at no cost to taxpayers. The first is to develop further guidance on central counterparty (CCP) resolution which will build on an existing paper on the key strategies and plans that CCPs need to develop. A second is to finalise the remaining elements of the total loss-absorbing capacity (TLAC) standard including implementation guidance and disclosures. Thirdly, to develop further guidance to support the resolution planning work of authorities and firms including ways that access to financial market infrastructures can be maintained during unfavourable market conditions. Lastly, to develop the “Key Attributes” assessment methodology for insurers which was endorsed by the G20 in November 2011. This regime sets out the “responsibilities, instruments and powers that resolution regimes should have for all parts of the financial sector that could cause systemic problems.

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