"TOO BIG TO FAIL" IS STILL A THREAT TO THE FINANCIAL SYSTEM / THE FINANCIAL TIMES COMMENT & ANALYSIS

15, 2013 3:21 pm

 

‘Too big to fail’ is still a threat to the financial system

 

By Bob Diamond

 

 

Politicians, regulators and banks need to co-ordinate a resolution regime, writes Bob Diamond

 

 

Five years ago, I was in the New York Federal Reserve building, engaged in discussions with Hank Paulson, then US Treasury secretary, Tim Geithner, the New York Fed president, and others. We were meeting about the possibility that Barclays could acquire Lehman Brothers, which was teetering on the verge of bankruptcy. It soon became clear that neither regulators, legislators nor bankers were equipped to prevent the collapse of a leading global financial institution.

 

When regulatory obstacles prevented the acquisition and Lehman declared bankruptcy, shockwaves channelled throughout the global financial system. Would the market have been calmed by a deal to save Lehman? No one can be sure. A frightening few weeks followed as funding froze and equity markets plunged. In the future, an event such as the Lehman bankruptcy and the turmoil that followed must be prevented.

In the five years since, legislators and regulators have made real strides to stabilise the financial system. There are stronger standards for capital and liquidity. Among the 18 largest US bank holding companies, tier one capital ratios averaged 11.3 per cent at the end of 2012, more than double the level at the end of 2008. Bank leverage – which was, we can now see, too high in the boom years – is now 50 per cent lower than it was pre-crisis.

There is also greater transparency and standardisation in the derivatives markets, improved consumer protections and more robust mortgage underwriting and securitisation standards.

While this progress is encouraging, it has proved insufficient to end the “too big to fail” problem. Political leaders, regulators and banks need to collaborate on the core issues in an internationally-co-ordinated effort to establish a robust resolution regime. Why is finding a solution to this problem so important? Without an international plan to wind down an important bank in an orderly fashion, political and regulatory leaders are compelled to create more rules – often to protect national and regional markets and economies.

 

So, first and most important, we must establish a global resolution regime that is rigorously tested – with ironclad protocols and agreements for implementation. Regulators across borders must have clear responsibilities and be prepared to act on them.

Extensive work is under way among authorities in the US, UK and EU. The Federal Deposit Insurance Corporation, the Federal Reserve and the Bank of England have made significant progress, which is critical given the concentration of banking assets in these markets. With a resolution regime being the most important element for solving too big to fail, its completion must be a top priority for financial regulators.

Second, big banks must be subject to the same or very similar levels of capital, liquidity and leverage across all large markets – with the same definitions, calculations and timetables for implementation. A level playing field, based on the international standards set by the Basel Committee, is essential to ensure banks have consistent and predictable financial targets.

A global framework is required if we are to avoid the kind of capital regulatory arbitrage that weakened the financial system and helped to create the conditions leading to the financial crisis. All regulators and banks, everywhere, must adhere to the same transparent rules.

Third, rules must be consistent and co-ordinated. One of the biggest challenges to ending “too big to fail” is that competing rules drain confidence and trust in the regulatory framework.

 

Regulators in the US and Europe are at risk of applying different capital and leverage rules, and pursuing different market structure plans. The US “Volcker rule”, which is designed to curtail risk by banning proprietary trading at large banks, was not co-ordinated with other jurisdictions. Europe is pursuing an entirely different approach to separate trading and banking activity. Meanwhile, the UK has approved a plan to “ringfence” retail and commercial banking activity.

 

Finally, regulators must implement the final rules – and their effectiveness must be measured before new proposals are introduced. Promulgating new proposals may be in conflict with existing laws and could undercut the regulatory predictability needed for banks to lend and support growth.

Avoiding the next Lehman and solving “too big to fail” is well within our reach if regulators put in place a robust resolution regime, strong capital liquidity and leverage rules, and ensure consistency with other key regulations, including cross border derivatives and bank and market structure rules.

Implementing these measures will give confidence that the rules are strong and that regulators are co-ordinated and will be equipped to facilitate the winding down of failing banks in an orderly fashion.

If we do this, we will ensure that no financial institution is “too big to fail” and no taxpayer dollars will be used again to bail out our financial institutions. We will also ensure that banks are safer and sounder, and will be positioned to pursue the lending that supports jobs and economic growth.


The writer is former chief executive of Barclays

 

Copyright The Financial Times Limited 2013.