This was not supposed to happen. The failure of a medium-sized bank should not have had systemic repercussions within the US, let alone around the globe. Risks were assumed to be hidden in the opaque or unregulated parts of the financial sector, not in highly transparent instruments plainly in view on bank balance sheets. The resolution of systemically important banks was supposed to be governed by recovery and resolution plans (i.e. ‘living wills’), coordinated with supervisory colleges, and prevented by constant stress testing. In the first real-life stress tests of the regulatory body put in place after the global financial crisis, financial authorities in the US and Switzerland put the resolution playbook aside out of concern for spillovers and a full-scale financial crisis. Instead, the Swiss authorities chose to use emergency laws to support a takeover of the failing Credit Suisse and to extend public liquidity support for the Swiss National Bank. The US chose to extend deposit guarantees ex post and created liquidity facilities ‘on the run’. After a decade of regulation and reform, the world seemed to be dangerously close to another ‘Lehman moment’.
It is understandable that this caused consternation and anger. Policymakers immediately started looking for responsible parties and calling for consequences. The Swiss parliament voted to reject the backstop for the deal (it has no legal consequences), and the US parliament grilled federal regulators for hours. It is certainly right that we need to learn the lessons from this new crop of banking crises.
At the same time, it is crucial to draw the right lessons. This will require careful analysis of the causes and answers to questions such as:
- Were the bank failures idiosyncratic to highly specialised and/or poorly managed institutions, or symptomatic of a class of problems and structural issues?
- What were the differences between these failures and the ones during the global financial crisis?
- What role did the higher speed of deposit withdrawal play? Was this mostly about solvency or liquidity?
- What is the evaluation of the authorities' reactions? Did they do the right thing by choosing a mixture of bailout and bail-in (in the Swiss case) and putting aside other resolution options?
Regulatory, supervisory, and other consequences will need to be considered carefully, including:
- What are the consequences for liquidity and equity regulation? Do we need to rethink intervention points if a global systemically important bank (GSIB) is deemed not viable despite fulfilling regulatory capital and liquidity requirements?
- What are the consequences if recovery and resolution plan (RRP) options are seen as too risky in a fragile market environment?
- Would there ever be circumstances where a GSIB could travel the path of the RRP without large financial spillovers and contagion?
- In the European banking union, the Swiss solution would not be possible because of the strict bail-in requirement, and it would be difficult because mergers may have to be cross-border. What follows from this?
- What should be the role of bail-inable instruments? Should they be a buffer of debt that can be bailed in a going concern? Or does additional tier 1 (AT1) de facto become ‘gone concern’ instruments?
- What are the lessons for central banks? Should they take more explicit account of the effect of monetary policy on financial stability?
- What are the consequences for supervisors? What instruments and powers should they have? How can timely intervention be assured?
- Should supervisors be equipped with more circuit breakers to combat market manipulation in illiquid markets?
- Is it time to contemplate radical, structural reforms such as narrow banking? What would be the likely unintended consequences of any reforms?
As the debate on these issues and the lessons to be drawn is just beginning, it is clear that a consensus view has not yet been reached. That is why this new VoxEU debate invites contributions from experts to help clarify the key lessons and identify paths for reform. Through an open dialogue and diverse perspectives, we can better understand the root causes of the recent banking crises and develop effective solutions to prevent crises in the future.