Bid to guard against bank failure slows

Industry analysts warn the job could take years

— Five years after the collapse of Lehman Brothers, a global push to tighten financial regulation around the world has slowed in the face of a tepid recovery and a tough industry lobbying effort.

Important changes have been made: Banks in the United States and Europe have socked away capital to guard against a fresh economic downturn and evolving rules may force them to split off some of their riskier operations.

However, finishing the job “is going to take many years,” International Monetary Fund chief economist Olivier Blanchard said two weeks ago.

“It is conceptually very difficult, politically very difficult,” Blanchard said.

The post-Lehman goal of a global mechanism to immunize the financial system from another large-scale shock remains incomplete as big banks, insurers and other financial giants remain intact, raising the issue of whether they are “too big to fail.”

In addition, tools to guard against dangerous bubbles in the value of property or other assets are not yet in place. There is no agreement on how countries should coordinate the failure of a globally important financial company. Implementation of basic banking rules in major nations has fallen behind schedule.

“The global economy is such a complex animal, there is a lot of structural work to be done. We are discovering that there is still a fault line here, a fault line there,” said World Bank chief economist Kaushik Basu. “As this gets mitigated, there will be a period of difficulty and danger.”

Regulators have been confronted by a slow recovery by the world’s economy, making governments leery of doing anything that might make banks cautious to loan and invest. The financial industry has pushed back, warning that aggressive regulation might undermine growth. And regulators are still learning how modern finance can be made safe while still supporting economic activity.

The result: Some of the proposals once considered central to a safe, post-Lehman system have been delayed and weakened while others have been downplayed as too politically complex.

For other proposals, the world is heading toward a patchwork. Some major European nations, including Germany and France, are preparing to impose a tax on every financial transaction, while Britain and the United States have rejected the idea. There is a growing divergence, as well, over how involved banks should be in securities trading and investing.

In the wake of the 2008 Lehman collapse, there was a seeming groundswell behindthe idea that no institution should be so important to the economy that taxpayers would have no choice but to provide a bailout if the company faltered. The concept of “too big to fail” prompted the United States to rescue American International Group, the insurance giant known as AIG.

A follow-up move, a committee of central bankers and regulators operating out of the Bank for International Settlements in Basel, Switzerland, agreed that the most globally important banks should set aside extra capital as a cushion against losses, raising their cost of doing business and possibly acting as a brake against growing too large.

But the broader issue - how to prevent institutions from becoming too big, or how to guard taxpayers against a bailout - “is not yet satisfactorily addressed,” Blanchard said. Industry figures such as JPMorgan Chase chief executive Jamie Dimon, meanwhile, have disputed the concept that size and complexity in itself is a problem.

In the United States, regulators have proposed limiting the funding banks use to finance themselves as a percentage of the nation’s gross domestic product, but they would need congressional support to pursue the idea. Given the polarized political climate in Washington, analysts say it is unlikely that Congress will address the issue soon. Even if legislation cleared Capitol Hill, there would be a battle to get all global stakeholders on the same page.

“It would make sense to work through the debate over large banks” before imposing other rules proposed by the Basel committee, said Phillip Swagel, who served as assistant secretary for economic policy in the George W. Bush administration. “It seems like a waste to have banks spend lots of money figuring out how to deal with rules that would become irrelevant if they arebroken up.”

There also is no comprehensive global approach for addressing bank failures. Individual members of the Basel committee, including the United States, have established resolution plans in case their own lenders become insolvent.And the United States and Britain in December released a set of guidelines to handle a major insolvency - a potentially important agreement between two world financial centers.

Determining how to coordinate the collapse of a major multinational bank is an area where the IMF and others have had limited success in pushing for a broader global agreement. Such an agreement to share the fallout of a bank failure across national borders would probably make countries more willing to let institutions go out of business, rather than prop them up with taxpayers’ money.

Policymakers, however, seem unable or unwilling to rid the global financial system of weak banks, said Anat Admati, a Stanford University professor who calls for even tougher capital regulation in the forthcoming book The Bankers’ New Clothes.

“Some banks in Europe, even in the U.S., are very weak, with a lot of overhanging debt and unrecognized losses. But regulators do not face up to this,” she said. “Prompt corrective action, to prevent banks from becoming distressed,would improve the system. We need better ways to handle insolvent banks.”

The process of revamping global financial regulation got off to a strong start.

In the aftermath of the Lehman collapse, the Basel committee agreed on a set of ideas its members felt would make the financial system more secure. Coming alongside national efforts, such as passage of the Dodd-Frank financial regulatory overhaul in the United States, the Basel recommendations were meant as a sort of global overlay to ensure the rules of play were roughly the same in the world’s major financial centers. They are to be phased in over the next few years, but only eight of the 27 nations involved met the Jan. 1 deadline for issuing final regulations based on the Basel recommendations.

Meeting in Basel in January, regulators scaled back one key set of provisions that would force banks to keep the equivalent of larger levels of cash on hand to guard against a run on deposits or another fast-moving crisis.

Such highly liquid assets had been defined to includegovernment bonds - which traditionally can be sold quickly and at close to their face value - and excluded securities backed by residential mortgages, the bundled, complex assets that had triggered the financial crisis in 2007 when they proved difficult to sell other than at a steep loss.

The financial crisis in the euro zone showed a flaw in the approach when Greek, Portuguese and other government bonds plummeted in value. Smaller U.S. banks, meanwhile, argued that to completely exclude mortgages from the new “liquidity coverage ratio” would reduce their ability to make home loans.

When the final Basel rules on the issue were released, the required liquidity levels were reduced, mortgages were included in the tally and banks were given extra time to comply.

“Nobody set out to make it stronger or weaker as a standard but to make it more realistic . . . to make sure there was no impediment to financing recovery,” said Bank of England Governor Mervyn King, who chairs a Basel committee of central bankers and regulatory chiefs.

Business, Pages 61 on 02/03/2013

Upcoming Events