As we approach Dodd-Frank’s fifth birthday, a lot of analysis—some forthcoming from us—will look at just how well the reform package has worked to cure the ills that almost felled the global financial system. In my view, the cornerstone of that law was its ground-breaking renunciation of too-big-to-fail with a new orderly-liquidation authority intended to force all financial giants to stand on their own two feet. The FDIC has joined with global regulators since then to issue lots of pronouncements and, in the Financial Stability Board’s case, some detailed protocols, on who gets what when a global financial giant falters. A speech yesterday from a top Canadian regulator tells us, though, just how far we have to go before any of this can be said credibly to have killed the TBTF giant.
Canada has long chafed at the failure of U.S. law to differentiate its banks and sovereign bonds from the global riff-raff. The U.S. argues—with some justice—that it can’t pick and choose sovereign jurisdictions based on who’s closest or whom it likes best; all sorts of diplomatic hell would surely follow once winners and losers were differentiated. But the fact remains—Canada is indeed closer and, often, a whole lot better as a bank regulator than lots of other places. Thus, when rules fall hard on its banks, Canada understandably feels more than miffed.
This might just be a tiff between a way big country and a small one. But the criticism hurled yesterday on TBTF resolution has broad consequences for the credibility of the Dodd-Frank framework. Quite simply, if Canada demands a bilateral agreement spelling out what the U.S. will do with its banks in a crisis, how clear can the law really be for cross-border cases?
We have been constantly assured that it’s pretty clear because the U.S. and U.K. agree on a lot in the new framework predicated on a single-point-of-entry (SPOE) approach that seems to work, at least for big banks. But, for all the U.S. assets housed in the U.K. and vice-versa, a lot of banks from countries outside Britain matter here, sometimes a lot. The U.S. is bristling at host-country constraints where U.S. banks do business. Why, then, should Canada not do the same?
Canadian banks love it down here. Canadians flock to Florida, NAFTA protects a lot of cross-border financial flows, and—Dodd-Frank notwithstanding—the rule of law is pretty clear. Large Canadian banks thus have presences here that, even if not gigantic for the U.S., are monumental in terms of their overall global operations and getting bigger still as new deals get done. Would the U.S. wall off Canadian branches and capital-markets operations, especially those soon forced into intermediate holding companies? How would bankruptcy for a parent holding company in the U.S.—Dodd-Frank’s preferred approach—work in concert with a Canadian action at the top-tier parent in Toronto? Would, in short, all that’s here be ours and whatever’s left go to Canada, beggaring its banking system under acute stress?
Answering these questions will take time. That I am even asking them, let alone that senior Canadian officials are demanding answers now, points to the critical need for U.S. regulators—starting with the FDIC—to shed some light on how SPOE will work for whom when. It’s not enough to damn the large banks if their living wills come to be called not “credible.” For Dodd-Frank’s end to TBTF to have real credibility, regulators must also show that their resolution plans work in practice and under real stress. Start with Canada—they should be easy—but start.