Panellists at a web seminar hosted Tuesday by Central Banking on Air disagreed on the level of urgency for the establishment of resolution regimes.
The financial crisis highlighted the importance of bank resolution schemes but the need goes beyond this, said Simon Gleeson, a partner at Clifford Chance, a UK law firm. Gleeson, who also sits on the special committee on effective regulation at the Institute for International Finance, an influential banking lobby group: "There's no amount of capital that cannot be lost through bad lending decisions. Economists have forgotten that the banking system is just a transmission mechanism. If you have a credit boom, you will have a banking failure." That in turn meant there was a need for resolution regimes.
National powers were needed to conduct a receivership, set up a bridge bank or carry out a 'bail-in', said Gilbey Strub, a managing director of the Association for Financial Markets (AFME) in Europe, a trade body. "That can be done and there's already quite a bit of evidence that that is in progress." But, Strub added, global harmonisation would be difficult.
Brandon Davies, a member of the Financial Markets Group at the London School of Economics, went further: arriving at cross-border consensus on resolution regimes would prove nigh on impossible, he said. "The very basis of the rights of debtors and creditors are fundamentally different across the many jurisdictions and if you're going to try and bring those together, you're going to have a superhuman problem on your hands."
Harmonising insolvency regimes
Part of the difficulty in writing cross-border resolution regimes derives from the problem of different insolvency standards in different jurisdictions. Insolvency law "embeds some fundamental choices" about fairness and the rights of the individual, Gleeson said, noting that these concepts diverge in different jurisdictions.
Strub, who leads the AFME's work on bank resolution, used the United States and United Kingdom as an example. "Many of the early settlers in the United States were escaping debts. [In the United Kingdom], entrepreneurship was promoted and failure wasn't necessarily seen as a bad thing." She pointed also to differences between the way insolvency is treated in the United Kingdom and in Europe. Such differences persist, although they may not make sense, from a social perspective, to individuals in different jurisdictions, Davies said.
Look at capitalisation first
Instead of resolution regimes, Davies said, attention first needed to be focused on how banks are capitalised. "If you were to look at the capital of Lehman Brothers, [a failed US investment bank,] and had it been available other than in winding up, it amounted to about $150 billion. So Lehman could have been in a situation where it never needed to wind up. And if you look at the number of banks that have been saved in the rest of the world and look at the number where the full amount of the capital rather than the full amount of the equity was written off, you'd arrive at a very small number - it's basically the Irish banks, with a few other exceptions," Davies said.
One area where authorities had done a good job was in relieving the pressures of liquidity shortages, the panellists said. "What you've seen with asset prices is that they reflect not just credit but also liquidity. In an illiquid market, if you try to move [an asset] at the current price, you will mark the asset much lower than the risk adjusted cash price of that asset," Davies noted. "We've become fixated with markets as providers of liquidity, but market liquidity is endogenous and that's dangerous because as liquidity dried out, prices [fell]," he added.
Faced with an accelerating liquidity shortage, central banks did exactly the right thing, the panellists concurred. "If you read [Walter] Bagehot's description of the handling of the 1870's crisis, it was a perfect description of what a central bank should do," Gleeson said, pointing out that this was exactly what central banks had done in the recent crisis.
Davies said the European Central Bank (ECB), which on 2 December extended some of its emergency liquidity operations in response to deteriorating conditions in some eurozone countries, had done a particularly good job on this front. Central banks could, however, face problems in this respect. "There is a point at which you are providing credit... [and] I think that's where Jean-Claude Trichet [the president of the ECB] now finds himself. What the eurozone governments are handing him is not a liquidity problem anymore - it's a credit problem." This view is shared by some members of the ECB's governing council, such as Axel Weber, a frontrunner to succeed Trichet next November.