TBTF Resolution Options
The Bank for International Settlements has released a paper recommending a new approach to resolving very large banks (often called too-big-to-fail or TBTF institutions), differing in some important respects from the single-point-of-entry (SPE) method under development by both the U.S./U.K. and Financial Stability Board (FSB). The paper creates a template – called a creditor-funded recapitalization mechanism – to ensure that depositors and creditors have certainty over the extent of their risk at a stressed banking organization, relying on the presumed value inherent in a bank – not unsecured credit – to accomplish a resolution without moral hazard. Because of its focus on certainty, the BIS approach would require strict adherence to applicable claims hierarchies in each nation and does not include a “bail-in” debt provision, seeking to establish a balance between “stability” and “fairness.” However, the lack of a buffer for unsecured creditors could still lead to liquidity risk, an issue the paper seeks to address by suggesting that, at its outset, significant amounts of subordinated debt might be required from large banking organizations. The Basel approach raises significant issues in the U.S., where banking organizations (especially those now deemed TBTF) are not banks per se, but rather bank holding companies with subsidiary banks, broker-dealers and insurance companies. The BIS plan believes it handles such situations, but it is unclear the extent to which it in fact does so where resolution protocols (e.g., SIPC and state insurance guaranty funds) apply. It is also unclear how conflicts related to derivatives are handled and the extent to which cross-border differences in claims hierarchies are resolved in this approach.
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