Last month Mark Carney, head of the Financial Stability Board as well as governor of the Bank of England, told us that the problem of banks being ‘too big to fail’ had been solved. If only. He wants systematically important banks such as HSBC to hold more equity and debt, enough to absorb losses when they come under pressure. He is pinning his hopes on the new concept of ‘total loss-absorbing capacity’ (TLAC), which he reckons should be worth between a fifth and a quarter of risk-weighted assets, as sufficient to prevent a taxpayer bail-out at the next financial crisis. He described this as a “watershed in ending too big to fail”. However this is declaring Mission Accomplished a bit too soon. There are grave doubts whether his ‘solution’ is anywhere near adequate.
First, the new rules won’t come into force till 2019, by which time the big banks will have to raise hundreds of billions of dollars/pounds to achieve their TLAC, and the idea is that regulators can then ‘bail-in’ the holders of all loss-absorbing money by wiping them out or converting their holdings into shares. The snag here however is that many of these investors will be pension funds and insurers which makes imposing big losses on them politically problematic. Think of the headline: pensions wiped out to rescue greedy bankers!
Then there’s the question of whether Carney’s plan is practical. Several of the biggest banks like JPMorgan Chase and BNP Paribas as well as HSBC, have assets worth more than $2 trillion and more than a thousand subsidiaries. How will regulators then co-operate without a globally agreed bank resolution regime, to stop local assets being seized to protest national interests? There is also the danger that bank bail-ins will be subject to legal challenges, as has already happened in Portugal. An even bigger risk is that if much of the loss-absorbing debt is held by hedge funds, contagion could spread across the financial system and bank to banks.
A third major doubt is whether Carney’s plan will work if it excludes 3 of the world’s 10 biggest banks by assets which are located in China where there are serious concerns about that country’s financial system. An even more pressing objection is that, rather than making some bank debt function more like equity by allowing it to be bailed in, why not simply force the banks to hold a lot more equity? Or coming back full circle to where we started from, why not solve the the too big to fail problem by splitting off the highly risky casino bits (the investment banking arms via a revised Glass-Steagall) and/or requiring banks to be smaller? Why not indeed?