NEW YORK – After the U.S. bailed out institutions deemed “too big to fail,” many of the largest global banks have expanded during the fiscal crisis, Federal Reserve Bank of San Francisco President & Chief Executive Officer Eric S. Rosengren told an audience in London today.
“Indeed, in many cases the sizes of the largest banks have become quite large relative to the sizes of both their home and host countries, Rosengren said, according to prepared text of his remarks, which were released by the Fed. “As a result, the ability – more specifically, the economic capacity – of many countries to resolve troubled global banks is, in some instances, in question.”
Some financial institutions became too big to fail “because they were so intertwined in the global financial infrastructure that their disorderly failure could cause the flow of financial transactions to freeze – calling into question the financial viability of their counterparties and the functioning of markets where they were key players. In essence, `too big to fail’ was really `too interconnected to fail’ or `too relied-upon to fail.’”
A solution to the “too big to fail problem,” Rosengren suggested would be creation of “living wills,” which would detail how banks would be handled if they become troubled. “However, for the tool to be effective, a global bank’s management team needs to have a clear idea of how regulators will react when a global bank becomes troubled. To truly be effective, a living will for a global bank would not only require a plan developed and kept up to date by management, but also an agreement among regulators in different countries that such a plan would be feasible – since supervisory, regulatory, and legal restrictions are country dependent. In essence, in the case of global banks, living wills may serve as a mechanism to encourage greater synchronization of supervisory policies across countries.”
The problem with “living wills,” he noted, is some problems “are not easily addressed by such living wills. Financial institutions that are critical market makers – or who engage extensively in complicated financial contracting not involving exchanges or clearing houses – are two possible examples. However, if the living will identifies these areas, the requirement could be made that they be run in separately capitalized subsidiaries, where these subsidiaries hold significantly more capital than other areas of the organization. Alternatively, the requirement could be made that such activities be run in independent companies – as activities that are not seen as appropriate to run out of large global banks.”
Rosengren said he opposes narrowing the activities of banks, because “even narrowly defined financial institutions can run into difficulties,” and problems of such institutions can still be transmitted to the broader financial system.
