Failing Banks’ Shareholders to Take Losses in U.S.-U.K. Plan

U.S. and U.K. regulators unveiled a plan for dealing with failing global banks that will allow them to fire senior executives as well as force losses on shareholders to protect taxpayers.

“A resolution strategy for a failed or failing globally active, systemically important, financial institution should assign losses to shareholders and unsecured creditors, and hold management responsible,” according to a paper jointly released by the U.S. Federal Deposit Insurance Corp. and the Bank of England in London today.

Global regulators are working on ways to handle the failure of large international banks to avoid another crisis like the one inflamed by Lehman Brothers Holdings Inc.’s bankruptcy in 2008 that led to taxpayer bailouts. BOE Deputy Governor Paul Tucker said the joint paper is a “significant step” toward solving the issue.

The U.S. has been developing its strategy under the Dodd- Frank legislation passed in 2010, while the U.K. has concentrated its efforts under the Banking Act of 2009, according to the paper. They each focus on dealing with the top of a financial group --the holding or parent company -- to minimize disruptions to sound subsidiaries.

The U.K. and U.S. plans -- aimed at ensuring continuity of banks’ “critical services” and reducing risks to financial stability -- are based in part on recommendations published by the Financial Stability Board, while U.K. policies are also linked to European Union proposals presented in June.

Creditors’ Losses

Both the Bank of England and the FDIC foresee that a wide range of unsecured creditors could face losses during a bank’s failure. Unsecured senior bondholders and uninsured depositors are among those who could take a financial hit, according to the paper. In the U.K., funds allocated to a national guarantee program for bank deposits could also be used to stabilize failing banks, the document says.

“The U.K. authorities are prepared in principal to stand back and let you execute a resolution” of the biggest U.S.- based banks “without stepping in and interfering,” Tucker told U.S. banking regulators at a forum today at the FDIC in Washington. “This is a journey that involves trust,” he said, and the example of the U.S.-U.K. relationship must serve to encourage other jurisdictions to follow.

While the regulators will co-ordinate their actions, there are differences in their methods, according to the paper.

Different Approaches

In the U.S., the holding company would be made bankrupt and losses assigned to shareholders and unsecured creditors, with soundly operating units transferred to a new entity. The U.K. plan involves either the writedown or conversion of securities held by creditors at the top of the group to return the entire firm to solvency.

Both regulators are continuing to work to ensure that “their respective resolution strategies will be fully operational,” they said.

Nobody will be let “off the hook” during a big-bank failure, which could create “a potential transformation of market discipline,” Tucker said. “Bondholders and other creditors will scrutinize the risks that banks are taking to a much greater degree than in the past.”

Existing banking giants have “far too many entities, thousands of entities,” Tucker said, and need to be simplified.

Paul Volcker, former U.S. Federal Reserve chairman, asked FDIC Chairman Martin Gruenberg whether the U.S. would similarly step back to let U.K. regulators handle dissolving a systemically important firm that reached onto U.S. soil. Gruenberg said he wouldn’t “presume to answer that.”

Gruenberg had previously outlined the approach his agency would take when using its Dodd-Frank authority to safely shut down a big bank holding company if bankruptcy won’t work. In May, he said foreign subsidiaries would be allowed to continue operations while the parent companies are being revamped.

To contact the reporters on this story: Jim Brunsden in Brussels at jbrunsden@bloomberg.net; Jesse Hamilton in Washington at jhamilton33@bloomberg.net

To contact the editors responsible for this story: Chitra Somayaji at csomayaji@bloomberg.net; Anthony Aarons at aaarons@bloomberg.net

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