G20 tries to roll back moral hazard in banks

November 6, 2009

An office worker leaves an Australia and New Zealand Bank mortgage centre in central Sydney September 1, 2009.   By Huw Jones
ST ANDREWS, Scotland, Nov 6 (Reuters) – Finance ministers from the world’s big economies launch difficult discussions this weekend on how to deal with banks whose failure could destabilise economies. Any blueprint is likely to take many months to thrash out.

Governments in Europe and the United States have ploughed hundreds of billions of dollars of taxpayers’ money into shoring up banks because they fear letting the banks fail could be disastrous. They want to avoid doing this in future crises.

So finance ministers and central bank chiefs from the Group of 20 nations, meeting in Scotland this weekend, will seek to clamp down on “moral hazard” — banks taking risks because they assume they will be bailed out if they get into trouble.

“We will have a debate about ‘too big to fail’, which will be the subject of quite a busy schedule in 2010, notably around the Financial Stability Board,” said a French official involved in the G20 meeting.

The FSB, made up of treasury, central bank and regulatory officials from G20 countries, was asked by G20 leaders in September to present proposals by October 2010 that may include requiring important banks to maintain especially high capital and liquidity levels.

“There are around six projects underway by the FSB for different types of scenarios,” the official said, adding that the FSB was determined to signal that the permanent survival of certain types of financial institutions was not guaranteed.

But the official added, “This is a subject on which you should not expect any precise decisions straight away.”

Banks are urging regulators to avoid focusing on size only and want a common, global approach to the issue, but countries have already begun taking unilateral steps.

In the United States, there are plans for a powerful resolution authority that could break up firms deemed too big or risky.

Meanwhile, Canada has been stressing the concept of “living wills” as a key tool for tackling moral hazard.

The September G20 meeting set an end-2010 deadline for major financial firms to develop such contingency and resolution plans, which would let them be wound up quickly if necessary with minimum disruption to markets and depositors.

Several major banks in Britain are already drafting living wills as part of a pilot programme.

Britain’s Financial Services Authority said this week it expected clashes with banks over living wills, and it has warned it may act to simplify corporate structures if a living will appears unworkable.

Around the world, however, many other questions remain unanswered about the idea of living wills, such as who would decide a bank was important enough to the financial system to require a will.

“It’s very messy,” said one central bank official.
An effective living will would have to include some sort of ringfence between risky activities and depositors. This could change the bank’s credit rating and stock market value, as some internal services and cost savings could be affected.

“The implications have not been thought through. The political message on this is well advanced of the technical preparations,” the central bank official said.

“A living will is entering a new territory. You enter the organisational freedom of a company.”

Deutsche Bank chief Josef Ackermann said this week that if the content of a living will became public, it would be an open invitation to corporate raiders.

The European Union is also concerned that the single capital market, which encourages integration, should not be fragmented if living wills created divisions and inefficient use of capital across the bloc’s 40 or more big banking groups.

But fragmentation may be the price paid to create a less risky system as bank branches come under pressure from national governments to become fully fledged subsidiaries, with their own capital and liquidity requirements.

“We are going to see more use of subsidiaries as a consequence of living wills,” Britain’s financial services minister, Paul Myners, said this week.

Britain has ruled out legislation similar to the old U.S. Glass-Steagall Act that would legally separate risky investment banking from commercial banking operations. But higher levels of capital and tougher liquidity requirements could have much the same impact.

“Living wills are shaping up to be a major threat and potentially a huge expense for banks,” said Paul Edmondson of law firm CMS Cameron McKenna.

“Banks will also fear that regulators around the world will use living will negotiations to unravel their corporate structures, which have been carefully crafted to avoid tax and minimise capital. This could be Glass-Steagall by the back door.”

(Additional reporting by Anna Willard; Editing by Andrew Torchia)

((Reuters messaging: huw.jones.reuters.com@reuters.net; + 44 207 542 3326; huw.jones@thomsonreuters.com))

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