FSA is missing a trick on living wills
ENTIRELY unsurprisingly, the FSA is increasing its budget, by a cool 16 per cent. One thing it should do with the money is to accelerate its plans for a new bankruptcy code for complex banks. This crucial reform – known as a special resolution scheme – would be based around living wills: a detailed guide explaining what to do to unwind the most complex universal bank in an orderly fashion while protecting the rest of the system and economy, as well as taxpayers. Such schemes, discussed at length by the FSA, the G20 and Vickers, have yet to be finalised, and are the missing piece in the jigsaw of financial reform.
Capitalism requires that bad firms be allowed to go bust, wiping out shareholders and staff contracts and hitting bondholders. Without this auto-corrective mechanism, losses risk being nationalised while profits remain privatised; not only does this warp incentives and encourages excessive risk-taking, it also robs the system of its basic morality. Any industry not subject to proper capitalist discipline will end up being regulated to death.
Lehman’s disorderly collapse showed that banks are different to many other companies because of their inter-connectedness; uncontrolled and unmanaged failure can trigger havoc, unlike with the bankruptcy of a small manufacturer. Yet the same is true of some other kinds of companies, such as nuclear power plants or airports; yet special bankruptcy codes already exist for these industries. They are covered by special, pre-agreed plans to allow them to continue to operate and be transferred seamlessly to new owners if the existing ones go bust. Similar procedures need to be introduced for banks.
Under such a system, bailouts (state provided equity capital or guarantees for bondholders) will become a thing of the past. If another UK bank hits the rocks, the authorities would be able to force through a bail-in by turning senior unsecured debt (and possibly also other kinds of liabilities) into equity overnight. On top of their equity buffers, all the big UK banks have much more loss-absorbing capacity that could be used to protect taxpayers and depositors.
It is a tragedy that such wind-down schemes were not in place four years ago. Regulators, who write bankruptcy law, are to blame. RBS could have been bailed-in without the need for taxpayer cash. Arguably, large insurance companies and the Big Four accountancy firms should also be covered by such rules. Some accountants and policy-makers have been discussing this for the past year or so; the issue is to make sure the Big Four could never suddenly become the Big Three or even the Big Two, eradicating competition and triggering government intervention.
There is intense frustration among those bankers who understand the need for urgency that the FSA is stalling on this issue. There are apparently too many other issues on the regulator’s plate. But this is a tragedy: the UK should pioneer resolution schemes, with UK banks used as global test cases. The only way the City will ever regain the moral high ground is if finance is finally truly reprivatised.
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