How to resolve a bank in distress?

LArs Nyberg of Riksbank has a nice speech covering the whole debate on the topic .

He began by noting that it is in practice difficult to allow banks, particularly if they are large and important to the financial system, to go bankrupt in the same way as ordinary companies. This was made clear during the recent financial crisis, for instance, when a number of banks around the world were rescued and in many countries taxpayers had to foot rather substantial bills. In a normal bankruptcy the shareholders are the first to be affected by losses, followed by the creditors. But if a bank is saved from bankruptcy, the creditors and actually often the shareholders are also saved from losses. Instead, the taxpayers suffer. This is clearly wrong, said Mr Nyberg.

 What we need is legislation for banks that cannot be allowed to go bankrupt like normal companies, which ensures that shareholders and creditors will foot the bill if the bank is mismanaged and becomes insolvent. Mr Nyberg said that one of the hot topics this spring, both in Sweden and abroad, is how to formulate suitable legislation for this.

 He went on to describe why banks cannot be allowed to go bankrupt like ordinary companies. But, he said, if the traditional bankruptcy legislation is not appropriate for banks, what kind of legislation would be suitable? He felt that some form of consensus on this was now emerging in the international discussions. Mr Nyberg also described the components he considers important in such legislation.

 Firstly, the state needs to be able to intervene at an early stage if the bank is to survive. This means before the bank is formally declared insolvent. The intervention then needs to be followed by a speedy procedure.

 Secondly, the state needs to have special tools to effect a resolution. These tools must give the authorities the possibility to sell and restructure a bank, for instance, by dividing it up into a good part and a bad part.

 One also needs to have, as a last resort, the possibility of a state takeover. This is a sensitive issue in certain parts of the world, but it is sometimes necessary. It is then better to have regulations on how to do this, rather than to deny the possibility of it happening, according to Mr Nyberg.

 Of course, the best thing would be if one could avoid the state taking over banks. But then one would have to find other ways of improving the distressed bank’s capital situation if it is to carry on. One alternative is to write off some of the debts, or convert them into shares. This is called a “bail-in”. Mr Nyberg went on to describe different forms of bail-in, but also said that there are still some problems that need to be resolved in this area.

 After describing what should be included, Mr Nyberg moved on to talk about what is actually taking place. He gave a brief description of the regulatory frameworks in the United States and the United Kingdom and of developments in the EU. He also compared these with the components he believes should be included in the legislation, and with the Swedish Support to Credit Institutions Act.

 Mr Nyberg felt that all of the regulatory structures can manage the most important problem, namely resolving a bank so that the shareholders are the ones affected most, and not the taxpayers. But there are differences, and he pointed to three of them, namely the way creditors are treated, how views differ regarding state takeovers, and how small banks are treated.

 With regard to the latter, the treatment of small banks, Sweden is the country that differs, concluded Mr Nyberg. Unlike the United States and the United Kingdom, Sweden has no special regulations for banks that are not systemically important; instead the normal bankruptcy procedure applies to them. Mr Nyberg argued in favour of a general legislation that can be applied to all banks. One important reason for this is that in real-life situations it is very difficult to determine whether or not a bank is systemically important, and each assessment contains a large measure of discretion. It does not feel right, Mr Nyberg said, that the consequences for so many people should unnecessarily be so dependent on assessments that are far from self-evident.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: