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Living Wills for Dying Banks

di - 24 Novembre 2009
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Why was that classic policy not even considered? This question is examined in detail in Milne and Wood (2009) but an important factor was manifestly the problems that would follow a bank closure even if contagion were prevented.  Contracts would have been left unsettled for the length of the bankruptcy proceedings, and firms and individuals would have suffered from the sudden loss of banking services.[2] These were not such problems in the 19th century, when the lender of last resort concept was developed and used. And in the 20th century British banking had been so stable that no-one had noticed, or at least acted on if they did notice, the emergence of these difficulties.

No-one wished the only feasible response to a bank’s being close to insolvency being to nationalise it. The Treasury Select Committee of the House of Commons, in its report into the Northern Rock failure, recommended that there be a special insolvency regime for banks, so that they could be taken over before becoming technically insolvent, and run down in an orderly fashion, or sold off in whole or in part, just as they can be in the USA. This proposal was quickly adopted, and the technique has already been applied to a small building society which was in difficulty.

Why then is there call for a “living will” for banks? Given that banks can now have orderly funerals promptly conducted under the new legislation, why should they bother with “living wills”?

Large Banks

The existing legislation applies in principle to all commercial banks and building societies. It does not however cover investment banks even in principle, and while it does in principle cover large, complex, international banks, there are, surely correctly, doubts about whether it could be applied to them.

Why do these doubts arise?

There are doubts about the applicability of the current prompt closure procedure to investment banks simply because these banks are not deposit taking institutions, but rather institutions which arrange deals and act as counterparties in complex transactions. A very important aspect of the latter is shown by their role in structured products such as the fairly widely sold “guaranteed equity return” funds. These guarantee a minimum return from a portfolio in return for there being a cap on returns from the portfolio. The closure of Lehman’s has cast a good number of these products into jeopardy. Orderly closure along the lines of prompt corrective action would not help much here, nor would it help with, for example, holdings of credit default swaps.

International banks because they have assets and liabilities in many countries can if they face an emergency capital shortage call on many countries – which could mean that no country felt responsible.

And large banks could, quite simply, be beyond the capacity of the liquidators to understand and wind down in a reasonable period of time.

These are the problems “living wills” are designed to deal with.

What the Wills would do

Essentially, they would tell an outside how the bank worked. Of particular importance, they would clearly assign different assets and liabilities to different subdivisions of the bank. They would provide an accessible list of counterparties, and their associated transactions. They would clearly describe provisioning and write-off procedures that had been adopted in particular cases and were adopted as general rules. In short, just as a person’s living will lays out what should be done when he or she can no longer do it for themselves, so would a bank’s living will provide all the information needed for someone to intervene when it was in trouble and run it down (or otherwise dispose of it) in a prompt and orderly manner.


2.  In addition many individuals would have lost a portion of their deposits with Northern Rock, and this was politically unpalatable.

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