Newspaper article International Herald Tribune

New Approach for Handling Bank Failures

Newspaper article International Herald Tribune

New Approach for Handling Bank Failures

Article excerpt

Regulators in the two countries have said that they are cooperating on measures that would be used to seize an ailing financial company that does a lot of business abroad.

It is one of the thorniest problems hanging over the financial system: How should the authorities deal with the collapse of a sprawling global bank to protect the overall financial system?

In an attempt to find ways to address this problem, regulators in Britain and the United States said Monday that they were cooperating on measures that could be used to seize an ailing financial company that does a lot of business abroad.

The intent is to avoid the problems that occurred when the investment bank Lehman Brothers failed in 2008. The unwinding of Lehman was complicated by the fact that it had substantial operations in London that were subject to British law. The same problem could recur because most of the largest U.S. and British banks have major subsidiaries in each other's countries.

In a joint paper, the Bank of England and the U.S. Federal Deposit Insurance Corp. laid out a preferred strategy for handling such bank crashes.

"It's great that these two organizations are pushing forward on it," said Phillip L. Swagel, a professor at the University of Maryland who was assistant secretary for economic policy under Treasury Secretary Henry M. Paulson Jr. "If they do get it right, then, yes, 'too big to fail' has ended."

"Too big to fail" is the label for the problems government must face when a large bank is on its last legs. In that case, officials want to avoid a future taxpayer bailout of the bank, even though letting the bank collapse could cause a run on the financial system.

In 2008, Lehman was allowed to fail but the insurer American International Group was saved by a U.S. government bailout because its collapse was seen as too much for the system to bear.

Since the crisis, legislators in Britain and the United States have passed laws intended to give regulators ways to avoid either outcome. In essence, they aim to take control of sick banks and keep them operating while passing losses on to shareholders and, if necessary, creditors.

The paper from the Bank of England and the F.D.I.C. focused on one way to accomplish this: The relevant regulator would take control of the bank's parent company, then embark on a restructuring.

By saying that they are focusing on the parent company, regulators hope to shape expectations in the market and minimize destabilizing uncertainty when a bank falters. This approach "will give greater predictability for market participants about how resolution authorities may approach a resolution," the regulators wrote.

The strategy then aims to put a seized bank back on its feet.

In most cases, the bank would be insolvent at this stage, meaning that losses had already used up all its equity. …

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