No more taxpayer bailouts for British banks
Bank of England explains how it will deal with failed banks in future, and it won't involve taxpayer money.
The Bank of England has set out its new plan for dealing with failed British banks, making clear there will be no repeat of the taxpayer-funded bailouts of the financial crises.
The plan covers three distinct stages:
Stabilisation phase
Once a bank, lender or deposit-taking firm has entered the Bank of England's 'resolution' process, it will decide on how best to stabilise the firm. This may be through transferring some of its business to a third party, or through a 'bail-in' of bondholders to recapitalise the failed firm.
Restructuring phase
Once the firm has been stabilised and recapitalised, it will need to restructure to address the causes of failure and restore confidence.
Exit from resolution
This is the end of the Bank’s involvement with a firm in resolution. Either the firm will cease to exist, or it will be restructured and no longer require liquidity support.
This new three-step regime will come into force in January 2015, in order to comply with the European Union's new Banking Recovery and Resolution Directive.
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Bank bosses and bondholders bear the brunt
In practice, what does this new programme mean - and, most importantly, how will it insulate British taxpayers from yet another round of bailouts?
The first thing to note is that the Bank will have powers to dismiss a failed bank's directors and senior managers within 48 hours. Had this power been in force in 2008, it would likely have led to the swift dismissals of bosses such as Fred Goodwin at RBS and Adam Applegarth of Northern Rock.
The second important power taken by the Bank is the right to impose losses on bank investors, including shareholders and bondholders. In an extreme scenario, shareholders could be completely wiped out and bondholders forced to convert their bank debt into equity (shares). This did not happen during the 2007/2009 financial crisis, largely because UK authorities were worried about senior bondholders losing faith in UK bank debt.
By bailing-in creditors, the Bank of England hopes to keep banks operating, while avoiding any need for taxpayer backing. However, forcing bank investors and creditors to suffer losses could lead to massive lawsuits and global haggling between regulators later down the line.
The Bank's other major concern is to ensure that bailed-in banks remain open for business and that payments to individuals and companies continue to flow. It is also important that depositors can access their savings, even during bank runs such as that seen at Northern Rock in mid-September 2008.
The Bank's new rules will require banks to burn through 8% of their liabilities before going cap-in-hand to the State for help. Royal Bank of Scotland, which got a £45.2 billion bailout in October 2008, would not have reached this 8% threshold at the time of its near-collapse, largely because its balance sheet had swelled to a gigantic £2.4 trillion (larger than the entire UK economy).
Only in extreme cases - where bail-ins, asset sales and customer transfers have proved inadequate to stabilise a bank - would public money be used to bail-out a firm. Initially, these last-resort bailouts will come from a resolution fund of £2.6 billion, which will be funded by the current bank levy and is equal to 1% of UK savers' deposits.
Sir Jon Cunliffe, the Bank's Deputy Governor for Financial Stability, said: "The Bank seeks to ensure that firms, whether large or small, can fail without causing the type of disruption that the United Kingdom experienced in the recent financial crisis and without exposing taxpayers to loss."
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Good news for taxpayers, bad news for owners and creditors
Clearly, reducing the risk of taxpayer bailouts during future banking crises is welcome. However, in order to reduce future risk to UK taxpayers, the Bank of England has loaded more risk into the laps of bank bondholders and, even more so, bank shareholders.
Under the Bank's new regime, shareholder wipe-outs could well be a much more likely event. What's more, a failing bank's unsecured creditors would share the losses by seeing their claims written down. Similarly, dealings in a bank's debt would be frozen, with bondholders later given tradeable certificates in place of their bonds.
That said, the Bank of England claims that, under its new regime, shareholders and creditors would not be worse off than they would be if a failed bank entered insolvency. Even so, with the biggest banks having assets and liabilities in the trillions of pounds, winding up a big bank will remain a messy and drawn-out affair.
Safer British banking
When the UK enters its next financial crisis, we will have a defined framework for dealing with failing financial institutions. It's high time that we had robust rules and better forward planning to cope with the next emergency. While bank shareholders and bondholders may grumble about this new framework, orderly bank failures, greater financial stability and the end of Too Big To Fail are worthwhile goals.
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Comments
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The most important thing is to ensure as far as possible that the costs are borne by the people responsible for causing the collapse. It is of paramount importance that the money belonging to ordinary account holders is protected. People must be able to use the financial institutions without fear that their savings could be wiped out. The existing protection limits do not go far enough.
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I agree with ARBLASTER and would go further if in charge! It seems ridiculous artificially to protect savers in preference to shareholders and bondholders etc. This is purely for understandable political reasons, but we already have a welfare state - so why do we need more and more complicated legislation to duplicate it unnecessarily in other areas... Slightly unrelated, but on the same principle, I disagree with the way that the insurance industry has been forced to subsidise homes in flood plains from all of our premiums.
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"...and it won't involve taxpayer money." Well, yes it would: "Only in extreme cases - where bail-ins, asset sales and customer transfers have proved inadequate to stabilise a bank - would public money be used to bail-out a firm." The taxpayer still has to stick his hand in his pocket because the bank would still be Too Big to Fail. There is no need for the Bank of England to have the power to sack executives. The two executives named in the article, Goodwin and Applegarth, fell on their swords pretty sharpish anyway. The best thing in my opinion is to have as little legislation as possible, and reintroduce the capitalist method. The bank is allowed to fail, and the jackals move in and take the best parts of the business. When Northern Rock hit the rocks, there was a consortium formed by Sir Richard Branson which offered to take the bank over. But in went the taxpayer's money instead. A change of government, and Northern Rock was acquired by Virgin Money anyway. The problem with the government taking over an ailing bank is that that ailing bank becomes a stealth tax. Look at what has happened with RBS group. Instead of letting the rescue squad get on with turning the bank around, so that it can be sold off, the government has imposed fine after fine on it for one thing or another just to move money from the taxpayer and the RBS customer to the government. I am afraid I see nothing in the Bank of England's proposals that will change this.
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27 October 2014