Recovery & Resolution & Insecurity

In a regime of “too big to fail” the taxpayer bailed out banks. Whilst expedient at the time this led to the perception that the larger a bank was the safer it would be. Many large depositors pared back their counterparty list just to deal with 3 or 4 “prime” names. But large banks took this a lot further. They only lent to each via repo - a situation that now prevails. For small banks and building societies that don’t do this how safe is a deposit with a clearer? Can you still rely on being bailed out? Probably not……… In the new regulatory regime the FSA is requiring banks to put in place recovery and resolution plans. This is sensible. It means that there is an orderly demise and/or restructure of a failed bank. It protects those who need protection and reduces systemic risk. Importantly it protects the taxpayer. But what does the regulator say about unsecured debt? Let’s look at consultation paper 06/11 published by the FSA in August last year: “It must be possible for a firm to be resolved in such a way that ensures that shareholders and uninsured creditors bear appropriate losses as they would do in a normal insolvency, rather than benefitting from the immediate need to preserve financial stability or the continuation of essential services as they would do if the firm was bailed out”. Assuming this proceeds (and there is no reason to think it won’t) large unsecured depositors and holders of bank issued senior debt in future can’t rely on being bailed out. No wonder the big boys do repo. More on this theme later.