Karen Shaw Petrou’s memorandum to the Federal Financial Analytics Clients on why GSIB generalizations scuttle meaningful TBTF reform.
TO: Federal Financial Analytics Clients
FROM: Karen Shaw Petrou
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DATE: August 19, 2016
Why GSIB Generalizations Scuttle Meaningful TBTF Reform
As FedFin noted yesterday in a daily alert, the FSB’s report to the Group of Twenty fessed up to a startlingly-frank conclusion: global regulators still can’t tell if anything they’ve done yet has made giant banks more resilient under stress or resolvable if they aren’t. Undeterred, the FSB at the same time released the rest of its resolution to-do list, also detailed in one of our reports on the FSB’s efforts. I am left with an inescapable conclusion: the FSB can’t judge the impact of its post-crisis rulebook eight or more years on from the crisis, but it plans nonetheless to keep filling it up with still more dense, demanding rules some member nations will then continue to flaunt in law or practice. The problem with GSIB resolvability isn’t necessarily GSIBs; rather, it’s some GSIBs in some countries where the FSB’s wants are far afield from home-country will-dos, FSB like it or not. As a result, one needs to ask not only what can be done to make GSIBs safer, but also and more importantly whether a global framework based on the lowest-common denominator should continue to drive policy in countries doing the best they can to make big financial institutions as resilient as possible.
A simple, but serious problem with the FSB’s approach is that it makes top-line policy determinations – i.e., that GSIBs are still TBTF – based on wildly-disparate national practices. I have detailed this since a 2012 review of Basel’s rules pointed to the fundamental fact that some countries – e.g., the U.S. – believe even the very biggest banks should fail under the tough love of a functional bankruptcy law while others view their banks as “national champions” that are de facto, and sometimes also de jure, arms of the state.
So, to say that the FSB’s downcast confession about its systemic-resolution regime means that U.S. GSIBs are TBTF is to leap over the chasm of clashing national resolution practice. Notwithstanding the happy leaps big bank critics took upon hearing the FSB’s words yesterday, the real question here is whether U.S. GSIBs are resolvable in wake of the demands made on them by the Dodd-Frank Act and an array of new rules. The FDIC and FRB’s findings on the latest round of living wills of course resoundingly said no. Clearly, considerable work remains, especially with regard to GSIB complexity. This is still problematic not only because even some U.S. GSIBs still can’t find all their pieces, but also because – as the living-will decisions make clear – U.S. regulators don’t trust their cross-border colleagues to refrain from grabbing what’s good in the host country if what’s bad back home scares them.
U.S. regulators share an antipathy to subsidiarization with U.S. GSIBs, but they can’t have it both ways – either cross-border regulators have to come to terms with branched operations or U.S. regulators should make structural policies clear and then require U.S. GSIBs for policy reasons – not idiosyncratic, bank-by-bank reasons – to adhere to them. Subsidiarization has costs in terms of trapped capital and liquidity that, if it’s required, should be offset in rules now premised on integrated, consolidated BHC risk profiles.
Another issue confronting GSIB resolvability that’s squarely in the laps of policy-makers, not U.S. GSIBs, is how to handle derivatives and other “qualified financial contracts.” Although the FRB is doing its best to address this by mandating contractual automatic stays, U.S. policy has yet to make a clear determination of when it wants bankruptcy to apply and how then to make it work with or without OLA. Non-U.S. regulators are still farther behind on this critical resolution issue.
Another major impediment to GSIB resolvability – acknowledged to be sure by the FSB – is GSIB interactions with financial-market utilities like CCPs. The more OTC trading shifts into CCPs and similar infrastructure, the more the risk moves from one hand to another. Each clearing transaction has its risks regardless of who does the clearing unless who does the clearing has better recovery-and-resolution resilience.
As I’ve discussed before, the stronger GSIBs get, at least in nations such as the U.S. that are moving apace on capital, liquidity, and resolution standards, the weaker the financial system gets as vital clearing-and-settlement functions move to entities only now coming under regulatory scrutiny. Even if member nations come around to the FSB’s way of thinking and address CCP resilience and resolution, the years it takes for anything like this to occur means that there will be awesome gaps in the global financial market’s infrastructure about which still more GSIB sanctions can do nothing.
A couple of years ago, Mark Carney in his capacity as FSB uber-meister tried to solve for this by recommending what he called a “name-and-shame” approach to FSB rulemaking. However, shame is something no one seems much to care about when it comes to protecting national policies and very large banks. While some countries are trying hard to meet the most essential goal of post-crisis reform – ending TBTF – others remain so locked in the sovereign “doom loop” that international policy is a mirage. When the FSB reaches global conclusions based on wide variations in actual practice, all it does is discredit countries trying to reach tough goals and expose regulators making difficult decisions to still more political opprobrium that makes their job even harder.