Column: Still too big to fail

Sep 19 2013, 02:54 IST
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SummaryFuture Lehman-like crises can be avoided by simplifying banks’ structures if they can't be wound down

Lehman Brothers’ bankruptcy five years ago crushed the global economy, turfed millions of people out of their jobs and left governments groaning under hefty debt burdens. Since then, policymakers have been beavering away to make sure that a similar calamity never happens again. Measures to address many of the key problems have been taken or are in the works. But if a Lehman went bust today, there would still be havoc.

The main success has been in building up the capital cushions banks have to withstand shocks. Since the end of 2009, the big global banks have increased their shareholder capital by $500 billion—the equivalent of 3% of their so-called risk-weighted assets, according to the Financial Stability Board (FSB), the organisation tasked by the G20 countries to fix the financial system. They are also on track to meet tighter global standards nearly five years ahead of the deadline.

But even this success has to be qualified. The amount of capital banks are supposed to hold depends on the riskiness of their loans. But lenders have too much freedom to decide for themselves how risky a loan is, giving them the opportunity to engage in monkey business. Meanwhile, inside the euro zone, the job of building capital buffers has not been properly done because of a tendency to sweep problems under the carpet. Thankfully, regulators are onto both these issues so there’s a reasonable chance they’ll be solved.

Less progress has been made in combating the “too-big-to-fail” problem. If a financial institution is too big to fail, governments have a terrible dilemma: either they let it collapse creating financial chaos; or they bail it out at huge cost to the taxpayer. Five years ago, they tried both methods: Lehman was allowed to go bust but, once they saw the mayhem, governments bailed out the other big institutions that were about to go belly up.

Beefing up shareholder capital should reduce the number of institutions that come close to bankruptcy. But there will always be some that fall through the net. The policymakers’ plan when this happens is to “resolve” the bust institution—effectively winding it down in an orderly fashion.

This, though, is easier said than done. For a start, there need to be laws allowing the authorities to grab failing banks and restructure them over a weekend before panic infects the rest of the financial system. Other creditors also have to be “bailed in” if there

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