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IMF Staff Says Orderly Bank Restructuring May Shield Taxpayers

The restructuring of a bank’s balance sheet in an orderly way may mitigate risks and protect taxpayers from exposure to bank losses posed by too-big-to-fail institutions, the International Monetary Fund staff said in a report.

“Large-scale government support of the financial institutions deemed too big or too important to fail during the recent crisis has been costly and has potentially increased moral hazard,” IMF staff said in a report released today. “Various reform initiatives have been undertaken at both national and international levels, including expanding resolution powers and tools.”

One tool is the resolution authority, or a “bail-in,” to restructure the liabilities of a distressed bank and “mitigate the systemic risks associated with disorderly liquidations, reduce deleveraging pressures, and preserve asset values that might otherwise be lost in a liquidation,” according to the report. Such restructuring could include writing down the bank’s unsecured debt and possibly converting it into equity.

Global watchdogs are seeking ways to prevent any repeat of the government rescues of lenders that were judged necessary following the September 2008 bankruptcy filing of Lehman Brothers Holdings Inc. The Financial Stability Board, which brings together officials from the Group of 20 countries, the U.K. and the European Commission are working on bail-in proposals, the report said.

“The design and implementation of a bail-in power, however, need to take into careful consideration its potential market impact and its implications for financial stability,” the report said. “It is especially important that the triggering of a bail-in power is not perceived by the market as a sign of the concerned institution’s non-viability.”

In the U.S., the Dodd-Frank Act requires firms deemed systemically important to file plans with the Federal Deposit Insurance Corp. and the Federal Reserve setting out how they could be resolved if they should collapse.

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