UK: Too-Big-To-Fail | Can It Be Tackled?

Despite the many years that have passed since the global financial crisis, its causes and consequences continue to demand attention from industry and policymakers alike.

At the heart of the crisis was the dilemma posed by banks which were held to be "too-big-to-fail" (TBTF). Their sheer size, complexity and inter-connectedness made the prospect of their failure too harmful to contemplate. As a consequence, when those banks got into trouble, governments around the world chose to come to their rescue with financial aid – or "bail-outs".

The post-crisis consensus was that the TBTF problem had to be eliminated. A regulatory agenda was set out by the Financial Stability Board (FSB) to make it possible for large banks to fail in an orderly and predictable way – what we now know as bank resolution. But even in 2016, questions remain around whether the world's largest banks are still too big, too complex or too interconnected to fail, and whether this is a problem that can in fact be tackled by the post-crisis regulatory framework in its current form.

Today, Deloitte is launching a global report: Tackling too big to fail: the resolvability challenge for banks. We argue that tackling TBTF is indeed within reach, but that much more work has to be done by both banks and resolution authorities before this can be achieved.

Resolution and the post-crisis response to TBTF

In the aftermath of the financial crisis, G20 leaders at meetings in London and Pittsburgh in 2009 tasked the FSB with ending the TBTF problem. Its efforts to do so are characterised by two overarching workstreams:

  1. To make bank failures less likely: by increasing capital and liquidity standards for banks and other measures aimed at reducing risk in the banking sector.
  2. To make bank failures more manageable if and when they happen: by creating recovery and resolution regimes in each jurisdiction and resolution authorities to administer them that would step in to make the failure of a bank orderly and predictable, attributing losses to the bank's creditors and shareholders rather than taxpayers.

The second initiative – essentially one aimed at making the failure of a large bank possible without destabilising financial markets and, ultimately, the real economy – represents the core of the international community's push to end TBTF. This initiative is also one that is just starting to prove itself now (with the EU's resolution regime coming fully into force at the beginning of this year).

The drive to make banks resolvable

No one, however, wants to wait until the next failure of a major bank to assess whether or not the goal of resolvability has been attained. Resolution authorities must therefore determine ahead of time whether the banks within their remit are "resolvable" – meaning whether they could be resolved in a crisis without causing significant disruption.

Where those authorities find impediments to the resolvability of a bank, they have broad powers to remove them, if need be through forcing sweeping changes to a bank's business model, legal structure, strategy and activities.

This creates a significant challenge for banks. Becoming resolvable in the eyes of authorities is a post-crisis imperative – but how can banks achieve this? The resolvability standards set out by the FSB set some markers for evaluation, but interpreting these criteria in detail is difficult, and something on which the opinion (and risk appetite) of banks and the authorities they answer to may differ considerably. If authorities take a strict line – as those in the United States have already shown an appetite for – the operational, financial and structural transformation demanded of banks will be significant and costly.

The six resolvability drivers

In our report we have identified the six areas below as drivers of a bank's resolvability. Progress against each of them is essential to ensure that a bank can effectively transform itself into an institution that is manageable and flexible enough to be resolved in an orderly way. For each driver, we set out some of the most challenging aspects of the authorities' expectations, but also discuss a number of solutions and leading practices that we have observed.

These are also areas where we believe resolution authorities need to give much clearer guidance to banks, either individually or generally, in terms of what they expect of them, and when they will expect to see it. This kind of clarity can facilitate the planning and investment that banks will need to undertake in order to reach these goals.

There should be no mistake that implementing the solutions necessary to become resolvable will be costly, time consuming and operationally complex. That said, we believe that the banks that manage this most successfully will be those that find ways to harness synergies between their resolvability-driven transformations and efforts they would pursue in any case to improve their efficiency and competitiveness. If done well, resolvability can be used as an opportunity for banks to become leaner, more manageable and cost-effective entities that are better positioned to thrive in post-crisis market conditions.

The need to take action now

Taking a step back to look at the bigger picture, some have recently questioned the effectiveness of the post-crisis framework in ending TBTF, and whether the failure of banks carries just as much systemic risk today as it did in 2008. They go on to ask whether much stronger measures should therefore be taken, including limiting overall bank size or imposing capital requirements far surpassing those set out in the Basel framework.

Against this background both the private and public sector have a strong shared interest in demonstrating the effectiveness of the current rules. To do so, they still have much to do and need to work more closely together to develop a clear understanding of what banks can and should achieve. A successful drive to make the banking sector more resolvable should demonstrate to stakeholders that the post-crisis regulatory framework is indeed fit for purpose, and has credibly tackled the TBTF problem.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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