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International Approach to Failing Financial Institutions Sought

| Jan 9, 2014 | Analysis

Bilateral agreements are the future of global bank liquidations, according to panelists at the annual meeting for the Institute of International Finance (IIF).  Panelists emphasized that such agreements would allow national regulators to respond quickly, and predictably, to future multinational bank failures—before the consequences of a bank collapse ripple across the global economy.

Following the global financial crisis, the Financial Stability Board (FSB), an international body that includes all G20 members and the European Commission, published a report listing key recommendations for the efficient resolution of failing global banks.  The report sought to encourage standardized resolution systems, with expanded powers and scope.

united flagsMultinational banking poses an important challenge for regulators.  In a blog post earlier this year, economists Mark Jarsulic and Simon Johnson used Citigroup to illustrate the difficulties that multinational banking presents.  Citigroup has $1.9 trillion in assets, disbursed across 2,372 subsidiaries.  These subsidiaries are scattered across Britain, Germany, Hong Kong, and Japan—jurisdictions with distinct procedures for dismantling failed financial institutions.

Imagining what will happen if a multinational banking institution such as Citigroup fails reveals why standardized resolution systems and bilateral agreements are key to preventing future crisis under the FSB plan.

The plan emphasizes that operations should be preserved at the lower levels of a bank—i.e., the subsidiaries—in order to minimize the negative impact of bank resolutions.  In order to do so, however, banking regulators would need to ensure that subsidiaries are well capitalized regardless of their geographic location.

The FSB therefore proposed a “single point of entry” strategy that would involve placing the parent bank holding company into a receivership that will keep all of the institution’s liabilities.  The assets would then be placed in bridge holding companies that would allow regional subsidiaries to remain capitalized and continue operations.  In order to engage in this “top-down” approach to resolving a failed bank, however, it would be necessary for multiple countries to recognize the existence of the parent bank holding company—and, therefore, the actions of a foreign legal institution.

Without a standardized resolution system worked out before a crisis, this final step would likely encounter administrative delays because countries currently approach bank dissolutions differently.   Some countries rely on administrative agencies like the Federal Deposit Insurance Corporation (FDIC), which is tasked with selling assets and settling debts for failing banks, while others resolve bank failures through their court systems.

The problem is compounded because multinational banking institutions like Citigroup are becoming typical.

According to a paper by Charles Hendren, global, systemically-important financial institutions (G-SIFIs) typically kept more than 66% of their assets in overseas subsidiaries.  These “too-big-to-fail” institutions had assets exceeding an aggregate of $42.9 trillion by 2008—at the time, 70% of the global GDP.   This percentage might actually be even higher depending on how one defines what is a G-SIFI.

This is not to say that no progress has been made.  The FSB recommendations have prompted legislative changes in approximately seven countries, most of which are in Europe.  The U.S. and U.K. appear to be responding to this need as well.

At the IIF panel, Arthur Murton, Director of Complex Financial Institutions at the FDIC highlighted the efforts of his organization and its UK counterpart the Bank of England.  The two organizations have entered into a memorandum of understanding on multinational bank failure and have been planning “tabletop exercises” to resolve any issues arising from a U.K.-U.S. cross-border bank resolution.

The U.S. and U.K. also collaborated on the creation of a white paper that explicitly describes how each country would resolve a failing cross-border financial institution.

Paul Tucker, the former Deputy Governor for the Bank of England, emphasized that the U.K. is prepared to step aside if U.S. regulators need to resolve a failed bank with U.K. subsidiaries.  However, according to Tucker, the U.K. needs a formal “reciprocal commitment” allowing U.K. authorities to similarly resolve banks with “a meaningful presence in the U.S.”  In other words, resolving bank failures requires an enforceable bilateral agreement.

According to Murton, the FDIC is also working with German and Swiss authorities.  In a separate statement to the Volcker Alliance Program, Martin Gruenberg, the FDIC chairperson, detailed plans to reach a similar understanding with China and Japan.  Talks with Canada were also reported earlier in 2013.

Making progress on bilateral agreements with countries that rely on their court systems to resolve bank failures may be more of a challenge, according to some observers.  Japan and China fall into this category.  At the very least, if a foreign regulator initiates a bank resolution, creditors would need to apply to courts in Japan and China for recognition and enforcement of their decisions.  China, in particular, has been singled out by the FSB for significant reforms.



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