FSB's ‘too big to fail’ fix is years away

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Nearly five years after the start of the global financial crisis, the agency tasked with injecting stability into the banking system is making only slow progress on a key issue: what to do about institutions that are "too big to fail."

The Financial Stability Board, set up after the collapse of Lehman Brothers Holdings Inc. in 2008, has made headway on several fronts, according to Mark Carney, who chairs the FSB and is Governor of the Bank of England. He will present a series of progress reports to leaders at the Group of 20 meeting in St. Petersburg, Russia, on Sept. 5 and 6.

On "too big to fail" in particular, Mr. Carney told reporters at a briefing Monday in London that the FSB and G20 are still years away from implementing a solution. That means that taxpayers could still be on the hook for billions of dollars should another big bank fail.

"There has been a lot of progress, but [the key issues are] continuing to develop the mindset of international co-operation amongst regulators and supervisors," Mr. Carney said. "There has been tremendous progress made in the last four or five years, but this is sort of new territory for those organizations and the work on 'too big to fail' in many respects brings that to the fore."

Bank bailouts have been a sensitive topic since the financial crisis hit. Taxpayers in the United States and Europe have spent tens of billions of dollars rescuing institutions, often because governments felt they had no other option.

The FSB was created in part to address that problem by developing international standards that would prevent financial institutions and governments from getting into that position.

The FSB has identified 28 global banks and nine insurance companies, none in Canada, that qualify as so called "systemically important financial institutions," or SIFIs. Basically they are so large "that their distress or failure would cause significant dislocation in the financial system and adverse economic consequences," the FSB explained in a report released Monday.

The problem with too big to fail, according to the FSB, is that governments have no alternatives but to bail out these giants when they run into trouble. And the executives behind these institutions take big risks as a result, convinced they will be rescued.

Over the past two years, the FSB has developed a series of proposals to tackle too big to fail. They include better supervision of SIFIs, requirements for these institutions to have larger financial cushions to absorb losses and developing standards for how to wind up failed institutions "without severe systemic disruption and without exposing taxpayers to loss."

Monday's report noted that there are signs attitudes are changing. Since 2009, the 28 banks have increased their common equity capital by about $500-billion (U.S.), providing additional capacity to absorb losses.

Rating agencies and markets are also beginning to discount any implicit "too big to fail" assumptions for large financial institutions.

But the report also indicated the job is far from over. "If we are to resolve the issues related to SIFIs and in particular the problem of [too big to fail], further action is required from G20 countries, the FSB and other international bodies."

That includes each country committing to introducing legislation enacting the FSB's proposals and improving co-ordination between G20 members that have already done so, the report said.

Mr. Carney expressed confidence that the FSB's work on ending "too big to fail" will be successful and that G20 members recognize its importance.

"This is a fundamental issue at the core of the system," he said. "It's an issue of financial stability but it's a broader issue of fairness in the system of which leaders are aware and quite focused on."