Carstens: Regulatory performance during banking crises was ‘mixed’

The performance of bank resolution frameworks was “mixed” during this year’s banking failures, the Bank for International Settlements’ (BIS) general manager said on October 19.

Speaking at a conference in Panama, Agustín Carstens said while systemic stability was preserved, more public-sector support was needed than had been expected. Supervision is the more appropriate response than resolution, he added.

The US saw four bank collapses in the first half of 2023, the largest of which were Silicon Valley Bank in March and First Republic at the start of May. In Switzerland, regulators forced the sale of Credit Suisse to UBS in March.

Government support was meant to be unnecessary when bank resolution frameworks were implemented after the global financial crisis, said Carstens. “While the responses were effective, the authorities had to depart from the expected approach,” he said.

Adaptability was key, he said, as social media can create quick crises of liquidity and confidence.

“Issues such as banks’ loss-absorption capacity, the practical execution of bail-in and the cross-border challenges it involves, and the provision of liquidity in resolution are not new, or a surprise,” Carstens said. He emphasised recent bank failures give greater impetus to addressing these challenges.

Carstens called in to question the “credibility” of bail-ins saying, “greater loss-absorbing capacity in the failing banks would have been preferable”. A bail-in means mandated debt is converted into equity to cushion against or prevent insolvency.

He said banks should carry the necessary liabilities to absorb their losses in resolution. He said while international standards currently require only the largest banks to do so, that umbrella should be widened.

“A fundamental lesson of the great financial crisis was that banks’ shareholders and creditors should bear a large share of the cost of their resolution. Significant work has been carried out internationally over the past few years to make bail-in operational,” Carstens said. “But that work is incomplete. Authorities need to be confident that they can execute a bail-in and markets must believe that a preferred bail-in strategy is not just words on paper.”

Carstens added hybrid capital instruments need to be explained to and understood by investors, and regulators should examine the cross-border aspects of bank resolution.

Ad hoc emergency liquidity facilities should not replace a proper framework, Carstens argued.

“There is clearly a need to review liquidity frameworks to ensure that there are adequate funding sources,” he said.