Transcript Cross-Border Resolution Conflicts

Appropriate structure
for handling crisis
management
by Rosa María Lastra
Professor of International Financial and Monetary Law
Queen Mary University of London
Joint FMG – CCLS Conference
London, 30 January 2008
Introduction – A tale of greed and fear
The trigger of the current financial crisis was the US Sub-prime mortgage market crisis.
The major casualty so far in the UK has been Northern Rock, a classic banking crisis
triggered by liquidity problems.
The banking industry is inherently fragile and vulnerable to crises. The resolution of
banking crises is always problematic, since often ‘gains are privatised and losses
are socialised (Martin Wolf).
Who is to blame for the current troubles in the financial World? Some would say that
the mis-pricing of risk (Greenspan put) is the causa remota. Others would point to
macro-economic imbalances. The focus of this conference is not to discuss how
and why the crisis came about, but rather to analyse the regulatory response to
the crisis. My presentation deals with the appropriate structure for
handling crisis management. To this end I will discuss:
The scope of bank crisis management
Structure in the UK - The tripartite arrangement
Role of the Bank of England (central banking role)
Role of the FSA (role of regulators and supervisors)
Role of HMT (fiscal authority & role of politicians)
Cross-border considerations at the European level and
internationally.
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Scope of bank crisis management
Bank crisis management at the national level comprises an array of
official and private responses.
Any structural review ought to take into account this multi-faceted
reality: it is not possible to reform one part of the structure
without considering the others. As regards the official
responses, when confronted with failed or failing banks, public
authorities have at their disposal:
(1) The lender of last resort role of the central bank
(2) Deposit insurance schemes
(3) Government policies of implicit protection of depositors,
banks (the ‘too-big-to-fail doctrine’) or the payment system
(4) Insolvency laws (lex specialis vs lex generalis)
(5) Prompt corrective action and preventive mesasures (PCA
formal rules and other forms of prompt corrective action).
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The UK structure – the Tripartite
Arrangement
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The Tripartite arrangement does not deal with all the aspects of
bank crises management. It deals with (1) ELA and (3).
The Tripartite arrangement is a good structure to respond to the
problems of transferring supervision from the central bank
(Bank of England) to a separate supervisory agency (FSA),
while keeping the Treasury involved. However, the wisdom of
separating the monetary and supervisory responsibility of the
central bank remains a matter of controversy. This is a key
‘structural issue’. Given that supervision is a key instrument in
the maintenance of financial stability, depriving the central bank
of this instrument, makes the pursuit of the goal of financial
stability more difficult.
Why did the Tripartite arrangement fail in Northern Rock? Lack
of effective and timely communication, apparent lack of a clear
leadership structure, uncertainties surrounding the resolution
procedures (questions of EU law, timing etc), an ill-designed
deposit insurance system.... It needs reform.
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UK reform proposals
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It is anticipated that the FSA will be given new powers and
that the tripartite arrangement will be reformed (FT Interview
with the Chancellor, 3 January 2008). The UK Government is
also ‘looking at insolvency law’ and considering improvements
in the compensation scheme. The Government plans to
introduce new legislation in May.
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However, the HC Treasury Select Committee in its recently
published report (26 January 2008) “The Run on the Rock”
suggests that the Bank of England should be given new
powers. It recommends that a single authority – akin to the US
FDIC - be created (the Deputy Governor of the Bank of England
and Head of Financial Stability and a corresponding Office) with
powers for handling failing banks (ch. 5) and the Deposit
Insurance Fund (Ch.6).
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Resolution procedures and
deposit insurance in the UK
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DEPOSIT INSURANCE - Northern Rock exposed the deficiencies
in the structure of deposit insurance in the UK. A credible deposit
insurance system requires inter alia prompt payment of depositors and a
reasonable amount of coverage (neither too meagre to be non-credible nor too
generous to incur into moral hazard incentives). The Financial Services
Compensation Scheme was set up under the Financial Services and Markets Act
2000 (FSMA) as the UK’s compensation fund of last resort for customers of
financial services according to the Directives on Deposit Guarantee Schemes and
Investor Compensation Schemes. FSCS has no real ‘powers’ as opposed to FDIC
in the US insurer, supervisor and receiver of failed or failing institutions.
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RESOLUTION PROCEDURES - Northern Rock exposed the
deficiencies of the UK regime to deal with banks in distress. With
regard to bank resolution procedures, prevalence should be given to prompt
resolution and market solutions, while maintaining access to critical banking
functions in a crisis. Shareholders should bear losses. The Treasury Select
Committee (January 2008 Report) recommends a special resolution regime.
PRE-INSOLVENCY PHASE - The efficiency of bank insolvency law and
procedures would be greatly enhanced - in terms of minimising cost to taxpayers by the adoption of a system of a formal system of prompt corrective action
(akin to FDICIA), linking the intensity of supervision to the level of capitalization. The
Treasury Select Committee sees great merit in the adoption of PCA
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Cross-border considerations –
the European dimension
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The appropriate structure to handle crisis management cannot ignore
cross-border issues. Though regulation and supervision remain
nationally based, financial markets have grown international, and hence
the structure at the EU and international level must be reformed, too.
Though the ECB has so far successfully provided liquidity to the market
(in recent months) to alleviate the ‘credit squeeze’, the structure for
managing and resolving a cross-border financial crisis in the EU
is, in my opinion, inappropriate.
Cross-border crisis management in Europe presents additional
challenges for policy-makers and regulators, because of:
 European Monetary Union. The ECB has no European fiscal counterpart, which means that the relevant fiscal authorities are by definition at the
national level.
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Supervision remains at the national level - process of financial
integration, the single market in financial services - the ‘trilemma’
The ‘patchy’ and scattered legal framework
The complex ‘European Financial architecture’
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European financial architecture
Lamfalussy framework
ECOFIN
European Parliament
LEVEL 1
European and
Financial
Committee
EFC
Framework
directives
(co-decision)
EUROPEAN COMMISSION
ECB
Financial
Services
Committee
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Level 2
European
Securities
Committee
(ESC)
Banking
Securities
& UCITS
Level 3
Committee
Of European
Banking
Supervisors
(CEBS)
London
Level 3
Committee of
European
Securities
Regulators
(CESR)
Paris
Level 2
European
Insurance &
Operational
Pensions
Committee
(EIOPC)
Insurance
& pensions
Level 2
European
Financial
Conglomerates
Committee
•Comitology
Financial
conglomeratesss
Level 3
Committee of
European
Insurance and
OccupationalPensi
on Supervisors
(CEIOPS)
Frankfurt
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LEVEL 3
Banking
Supervision
Committee
Level 2
European
Banking
Committee
(EBC)
LEVEL 2
Secondary legislation
The trilemma of financial supervision
(Thygesen & Schoenmaker)
Stable financial system
National financial supervision
Integrated financial market
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A patchy and scattered legal framework
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Primary Law: article 105 EC Treaty and Articles 18 and 25
ESCB Statute LOLR & rules on state aid - Articles 87-89 EC Treaty.
Secondary law (pursuant to Art 47 (2) EC Treaty):
 Directive 2006/48/EC of the European Parliament and of the
Council relating to the taking up and pursuit of the business
of credit institutions (‘Recast Banking Directive’).
 Dir 2006/49/EC, ‘Capital Requirements Directive’ Directive
2003/6/EC, ‘Market Abuse Directive’.
 Dir 2002/87/EC, ‘Financial Conglomerates Directive’
 Directive 2001/24/EC on the reorganisation and winding up
of credit institutions.
 Directive 2004/39/EC on markets in financial instruments
(‘MiFID’)
 Dir 94/19/EC,‘Deposit-Guarantee Schemes Directive’.
 Dir 97/9/EC, ‘Investor Compensation Schemes Dir.”
MoUs (non-legally binding arrangements) – 2001, 2003, 2005
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Reform in the EU – recent proposals
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ECOFIN conclusions October 2007 calling for an
enhancement of the arrangements for financial stability in
the EU (co-operation (?) and review of the tools for crisis
prevention, management and resolution 2007-9)
 To revise the Winding Up Directive - Public
consultation on the reorganization and winding up of
credit institutions by the EU Commission
(http://ec.europa.eu/internal_market/bank/windingup/i
ndex_en.htm
<http://ec.europa.eu/internal_market/bank/windingup/i
ndex_en.htm
 To clarify the Deposit Guarantee Directive
ECOFIN conclusions December 2007 calling for a review
of the Lamfalussy framework (half-baked solution?)
Towards a single regulator????
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Cross-border considerations –
the international dimension
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The IMF surveillance function (akin to supervision at
the national level) ought to be strengthened to detect
incipient financial tensions and vulnerabilities in
international capital markets.
New rules (regulation) are needed to deal with crossborder bank insolvency. The Basel Committee has
established a working group (December 2007) to study
the resolution of cross-border banks.
The cross-border dimension was echoed in an article (Ways to Fix the
World’s Financial System) by Gordon Brown published in FT 25 Jan
2008: “As financial markets become increasingly interlinked, countries
must ensure they have robust and effective cross-border crisis
management arrangements…The IMF should be at the heart of this
reform…[with clearer responsibilities for financial stability]”.
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Concluding observations
Protection justifies regulation (preventive regulation) and
supervision.
The financial system has become very complicated.
Complexity frustrates accountability
Time is of the essence in any rescue operation. Central bank lending
over an extended period of time is typically an indication of insolvency
not of illiquidity.
As the Chancellor stated with regard to the handling of the NR crisis (p.
80 of 2008 Jan report, “The run on the Rock”) in his appearance in front
of the Treasury Select Committee:
What you need is a legal framework…
This framework – providing clarity, predictability and certainty – has a
national dimension, but also a European and an international dimension
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