University of Zurich Forum
Can Banking and a Market Economy Co-exist?
or “Is There Enlightened Banking?”
Wilson Ervin
Senior Advisor/ Former CRO
Credit Suisse AG
January, 2012
Slide 1
A Triangle of Participants
Individuals
The State
Banks
Slide 2
Financial Crisis: a Triangle in Trouble
Individuals
Disruption of finance
severe recession
Banks
The State
Bail-outs
Contagion, systemic risk
Slide 3
Many, many, many proposals to “fix the problem”
Basel 2.5, Basel 3
Bubble Busting
Lifeboats
Core Capital/ Hybrids
Systemic Regulators
Ring Fencing
Contingent Capital
Regulator Shopping
Subsidiarization
Gross Leverage
Consumer Protection
Volcker Rule
Size Restrictions
Compensation
Glass – Steagall II
Central Clearing
Board Governance
Narrow Banking
Derivatives Transparency
Repo Reform
MtM Accounting
CDS regulation / ban
Procyclicality
Bonus Taxes
Dark Pools
Rehypothecation
Bank Taxes
Shadow Banking
Money market funds
Transaction Taxes
Bank Resolution
Liquidity Regulations
. . . and . . . and . . .
Slide 4
But one reform is central: solving “Too Big To Fail”
Basel 2.5, Basel 3
Bubble Busting
Lifeboats
Core Capital/ Hybrids
Systemic Regulators
Fencing
“Addressing the
problem of ‘too bigRing
to fail’
is
Contingent Capital
Regulator
Subsidiarization
the next central
step inShopping
the reform program”
Gross Leverage
Mario
Draghi
Consumer
Protection
Volcker Rule
Size Restrictions
Compensation
Glass – Steagall II
Central Clearing
Board
Governance
Banking
“If the crisis has
a single
lesson, it isNarrow
that the
‘too big to fail’Repo
problem
must be solved”
Derivatives Transparency
Reform
MtM Accounting
Ben Bernanke
CDS regulation / ban
Procyclicality
Bonus Taxes
Dark Pools
Rehypothecation
Bank Taxes
Shadow Banking
Money market funds
Transaction Taxes
Bank Resolution
Liquidity Regulations
. . . and . . . and . . .
Slide 5
Can we fix
“Too Big To
Fail?”
Slide 6
Defining Success
Individuals
State
Banks
Resolution Authority Objectives:
1. “preserve operations that provide vital services”
2. “avoid unnecessary loss of value and contagion”
3. “ensure losses are borne by shareholders &
unsecured creditors – not taxpayers”
Slide 7
How To Do It?
 FSB Resolution Tools:
1. Sale of firm
2. Create bridge bank for critical functions; wind down remainder
3. Recapitalize bank by restructuring liabilities: “Bail-in Within
Resolution”
 Bail-in Within Resolution
–
–
–
–
–
A high-speed, pre-wired, forced recapitalization of the bank
No government capital at risk – not a bail-out
All systemic functions and customer activities continue as normal
No need for (difficult) emergency restructuring of businesses
Going concern approach preserves franchise value for creditors
Slide 8
Bail-in – an example
Old Balance Sheet
$600 bn assets
---------------$430 bn “franchise” liabilities
New Balance Sheet
 $575 bn (i.e. $25 bn write-down)
-------------- No change – remains at par
(deposits, retail, swaps, payables)
$120bn senior debt
 15% new equity (85% unchanged)
$ 25bn preferred & sub debt
 new equity
$ 25bn equity
 write-off or warrants
 Equivalent to a high-speed recapitalization for banks
– “NewCo” now well capitalized (well-priced assets and $43 bn fresh capital)
– No government capital at risk
– Customer activities continue as normal – going concern
Slide 9
Example –Impact on the System
Actual Lehman
Bail-in Pro Forma
1) Equity
2) Sub debt
3) Senior debt
10% to 25% recovery
~par (85% + shares)
Investor Impact
~$150bn of loss
~ $25 bn loss
wipe out
warrants
wipe out
shares
(= 5x - 6x asset loss)
– Customers*:
– Counterparties*:
(= 1x asset loss)
large losses
no loss
large losses
no loss
– Markets:
massive unwinds
& deleveraging
relief rally?
– Know Result?
up to 10 years
now
Low
“run”
pressure
Slide 10
The tough technical questions:
1.
2.
3.
4.
5.
Bank scope – SIFI’s only? G-SIFI’s? or broader?
Trigger choice – who pulls and under what rules?
Instrument scope – which instruments? (esp. derivatives? short term funding?)
Protocol – constructive ambiguity? or transparent rules?
Inter-creditor rules – how to balance different classes fairly
a) Sequencing and method of valuation write-downs
b) Write-off vs dilution, and order of application
c) Strict vs graduated priority?
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
A serious “to do” list
but solvable & finite
Will investors buy and at what cost?
Feedback effects? (e.g. runs, arbitrage)
Need and structure of liquidity support?
Execution issues. Capacity to handle multiple events?
Impact on systemic stress?
Grandfathering / Transition?
Safeguards & governance
Treatment of groups & legal entities
Legal elements
Cross border implementation
Cross border execution / ring fencing
Slide 11
What about systemic implications
Lowers Contagion:
 No losses for “franchise counterparties”
 No losses for retail clients - reduced pressure for “runs”
 Reduces losses dramatically for long term investors
Less Pressure on Financial System:
 Doesn’t “push the problem” to other banks (mergers) or into troubled markets
 Creates new equity where needed
 Doesn’t create ever bigger banks
Other Implications:




Relative simplicity - easier to execute
More predictable & transparent
Eliminates pressure on sovereign credit
Avoids unstable “beggar thy neighbor” – globally constructive
Slide 12
Bail-in: A sustainable and powerful approach
 Make resolution “practical” via going concern approach
– Not a taxpayer bail-out – use a bank’s own capital
– Protect deposits & key activities – remove path of contagion & runs
 Practical and effective with today’s banks
– Good backtesting results for all recent major bank events
– Access a huge pool of capital - can handle crises bigger than 2008
– Works internationally – doesn’t “export the problem”
 Improve outcomes for real economy; lower systemic stress
– Creates new equity for the system – avoid “deleveraging cycle”
– Better market signals to help discipline behavior
– Reduces pressure on government finances
Slide 13
A global issue: where are we now?
Slide 14
Regulatory Developments – Switzerland and
USA
 Pioneered many elements of bank resolution, including bail-in
concepts
 Existing law
 Expert Commission (2010)
– Emphasis on strong capital & protection of domestic functions
– Innovative use of Contingent Capital as part of capital
 Ongoing development of Ordinances / Consultations
•
•
•
•
Dodd Frank (2010) – legal basis for “Orderly Liquidation Authority”
Bail-in Within Resolution also permitted under law
FDIC stance evolving from “orderly liquidation” to “recapitalization”
Economist Roundtable (Dec. 2011): unanimous preference for bail-in
Slide 15
Regulatory Developments - Europe
In practice, such a [bail-in] tool might be most useful in the
case of systemically important institutions which are
considered to be “too big to fail’, or in a generalized situation
of stress where there is unlikely to be a large pool of
potential 3rd party purchasers.
European
Commission
DG Internal Market and
Services (January, 2011)
Most persuasively, if the social cost of a systemically important bank going
into insolvency is intolerable, there needs to be some mechanism for
imposing losses on liabilities in resolution (otherwise they benefit from a
government guarantee). This by definition is what bail-in provides.
. . . the authorities should have a ‘primary bail-in power’. . . to write
down liabilities to recapitalise a bank (or part thereof) in resolution.
Final Report, September 2011
Slide 16
Global Momentum
The new standard will address the “too-big-to-fail” problem by making it
possible to resolve any financial institution in an orderly manner and without
exposing the taxpayer to the risk of loss . . . endorsed by the G20 Leaders . . .
require jurisdictions to resolve a financial institution that is no longer viable,
including through transfers of business and creditor - financed recapitalisation
(“bail-in” within resolution), that allocate losses to shareholders and unsecured
and uninsured creditors in their order of seniority
“Key Attributes of Effective Resolution
Regimes for Financial Institutions”
G-20 Summit: October 2011
Bank Associations:
Slide 17