Last Friday, we argued that the U.K.’s Vickers report would mandate tough restrictions on large banks. So the Monday interim report did – or at least it did if one read the report, not all the press that sniffed about what the big banks got away with yet again. Capital was to be only ten percent – not the fifty percent some demanded – and big banks were allowed to stay in both commercial and investment banking under tough new firewalls – not driven apart, again as demanded by industry critics. At this point, we don’t know what policy-makers could recommend to please TBTF critics short of bringing back Mr. Bailey’s bank from the ?Wonderful Life? era.
To bring policy back to a reasonable balance, we need a far better informed debate about what’s systemic and how institutions that trigger it come under the taxpayer’s wing. Where governments plan to bail out big banks – e.g., as in the U.K. – stringent standards may well be warranted. But, where they don’t plan on it and can’t do it even if they want to – the U.S. post Dodd-Frank – the rules should be a lot different because the banking system is a lot different.
A critical issue in reform policy is handling cross-border resolutions of complex systemically-important financial institutions (SIFIs). But, the need for cross-border resolution doesn’t mean that SIFIs are consistently structured across sovereign boundaries. Managing the intersection of SIFIs in global markets is a critical systemic reform, but it doesn’t mean that SIFIs are the same wherever they reside.
A few key differences make this clear. Outside the U.S. the banking system in most nations comprises only banks one can count on the fingers of a single hand that hold assets multiple times larger than their home country’s output. This isn’t just true in tiny states like Iceland. It’s also true in the U.K., Switzerland and other major banking centers. In the U.S., in contrast, the biggest banks are SIFIs for sure, but not because they have gobbled up domestic GDP and then some. Even the biggest U.S. bank holds far less than U.S. national output. As a result, U.S. SIFIs can be dispensed with at far less systemic cost with enough advanced planning on their own part and that of their regulators. In part because of this signal difference in national banking systems, the U.S. has taken a dramatically different course on what to do for systemic resolutions. Under Dodd-Frank, it’s just said no to bail-out, with the new ?orderly liquidation? process clearly spelling an end to expectations of TBTF largesse. The exception, as we’ve noted in the past, is when systemic risk comes from out of the blue – 9/11, for example – but the presence of emergency backstops doesn’t suggests that SIFIs always get off scot-free.
Outside of the U.S., policy-makers are stumped about what to do the next time a SIFI stumbles. In part because the banking systems are so gigantic relative to home economies, bail-out seems destined to dictate policy the next time around. With bail-out deemed unavoidable, policy is turning to how to make the banks that benefit from it pay for it. As a result, global and EU regulators are focused on proposals like SIFI surcharges, systemic taxation and new forms of capital to force investors to take the fall in front of hapless taxpayers. Some of this may well make sense in the context in which it’s proposed, but none does in the U.S. if we’re serious about the Dodd-Frank mandate of ending TBTF.
Where the government is committed to pick up the pieces – FDIC insurance, for example – banks should pay for the privilege and where banks get federal backstops—e.g., the FRB’s discount window —rules to limit wild living are also warranted. But, if banks can die by their own hand – as Dodd-Frank rightly demands – they shouldn’t also be strangled by their regulators.