Living Wills for Dying Banks
Why the Wills are Important
These living wills would thus be important in two ways. First, they would ensure that when some institution, however large or complex, got into difficulties, it could be handled without major collateral problems. That in itself is a good argument for them.
Second, and associated with that, these wills would make future crises less likely. For they would ensure that no bank was ever again “too big to fail”. The “brooding presence” of the risk of failure would once again make bankers act in a prudent way.
Alessandro Roselli: “A Comment”
If I understand correctly, living wills are proposed within a regulatory framework that, at the same time, would keep the present banking structures and avoid the too-big-to fail issue: an alternative to the radical proposal of splitting them.
Living wills would be useful for broker/dealers and for large international banks. The independent broker/dealers are – or were, before the (quasi) collapse of the big 5 – very relevant in the US, less, I think, in Europe, where the universal bank model is fully adopted. These are banks that have access to the lender of last resort. The problem of international banks is more an issue of coordinating supervisors than of knowing better their subdivisions, internal procedures and off-balance structures (which should in any case be known to the regulator).
To whom the living wills should be made known? Just to the regulator or also to the counterparties?
My guess is that living wills can help, but perhaps their relevance shouldn’t be overestimated.
Geoffrey Wood: “A Reply”
I am greatly indebted to Dr. Roselli for his thoughtful comments. There is little difference between us. This response is primarily for the sake of clarity.
Living wills in Europe are indeed primarily for large banks, and in Europe most of these are on the universal model. That they have access to a central bank as lender of last resort is indisputable. But central banks provide only liquidity. The provision of liquidity can not deal with fundamental insolvency, although it can prevent insolvency from arising through a bank’s having to sell assets into a thin and distressed market.
Living wills are designed to deal with a bank which is running out of capital. Co-ordination of supervision across national borders would undoubtedly give better warning of this than we have had recently, but it will not prevent it happening, nor remove the need for the orderly handling of a bank approaching insolvency. Living wills are designed to make this easier. They will not of course make it easy; Dr. Roselli is correct to emphasise that living wills can help in such difficulties, but not to the extent of removing them.
And finally, to whom should the detail of such wills be disclosed? Certainly to central banks and supervisors. It would be up to the banks involved to decide whether they should be disclosed more generally. In the 19th century in Britain banks started to disclose their capital ratios to build up public confidence in them. If it were thought that disclosure of the detail of living wills (their existence would be public knowledge since all banks over a certain size would have them) would build up confidence in the institution, by for example showing it to have an orderly management with clear organisational structure, then public disclosure might start to become the general practice.
