It was around a year ago that Credit Suisse, which is a global systemic bank with $540 billion in assets and second-largest Swiss lender, established in 1856, failed and was sold to UBS. In the US, Silicon Valley Bank, Signature Bank, and First Republic Bank failed at almost the same time during the Federal Reserve interest rate hikes so as to contain inflation. With a combined $440 billion of assets, these happened to be the second, third as well as fourth biggest bank resolutions since the time the Federal Deposit Insurance Corporation came inti picture throughout the Great Depression.
This banking turmoil went ahead and represented the most significant test since the global financial crisis of bringing to an end too-big-to-fail—wherein a systemic bank can be resolved while at the same time preserving financial stability as well as protecting the taxpayers.
What is the verdict, then? In short, while there has been major progress which has been made, further work is indeed needed.
On the one hand, as one could note in a recent report, the action pertaining to authorities last year successfully went on to avoid deeper financial turmoil, and the financial soundness indicators for majority institutions signal continued resilience. Moreover, unlike many of the failures across the global financial crisis, this time prominent losses got shared with shareholders as well as some creditors of the failed banks.
But the fact was that the taxpayers were once again on the hook as extensive public support got used to safeguard more than only the insured depositors of failed banks. Amid a phenomenal creditor run, the Credit Suisse acquisition happened to be backed by a government guarantee as well as liquidity almost equal to a quarter of Swiss economic output. While public support finally recovered, it entailed very prominent contingent fiscal risk and went on to create a larger, more systemic bank. The use of standing resolution powers so as to transfer ownership of Credit Suisse to post-bailing shareholders and creditors rather than depending on emergency legislation to effect a merger may very well have seen Credit Suisse shareholders completely wiped out and potentially less public support broadened. One can expect to learn more in the days to come when a Swiss report on the too-big-to-fail regime gets issued.
In the United States, for instance, apart from easing collateral requirements for liquidity support, authorities cited systemic concerns so as to invoke an exception enabling protection of all deposits within two of the failed banks. This prominently increases the costs for deposit insurer that will need to be recouped from the industry over time. Even the very large as well as sophisticated depositors happened to be protected, not just the insured.
What has been the learning?
Intrusive supervision as well as early intervention are critical. Credit Suisse depositors went on to lose confidence after prolonged governance as well as risk management failures. In the US, the failed banks went on to pursue risky business strategies with not enough risk management. Supervisors, when it came to both cases, should have gone on to act faster and be more assertive as well as conclusive. The recent review of supervisory approaches found that the capacity and will to act are critical and can go on to suffer from unclear mandates or inadequate legal powers and resources, as well as independence and powerful financial sector lobbies. Policymakers are required to better empower banking supervisors so as to act early and with authority if required.
It is well to be noted that even smaller banks can get systemic. Supervisory as well as resolution authorities should make sure there is sufficient recovery and resolution planning for the sector. This should have banks that may not be systemic in all circumstances but could be in some. This was a major recommendation of the latest Financial Sector Assessment Program for the US.
Resolution regimes as well as planning need anticipated flexibility. Policymakers should make sure the resolution rules and plans are flexible enough to balance financial stability risks as well as taxpayer interests. Government support may still be needed in some circumstances, for instance, so as to avoid a systemic financial crisis. IMF staff recommended the equivalent of a systemic risk exception in the case of the euro area, for example. While authorities should continue to go ahead with Plan A, they require the flexibility to depart from and, for instance, combine different resolution tools as required by the specific circumstances at the time of failure.
Liquidity within the resolution is crucial. Banks typically go on to fail due to the fact that the creditors lose confidence, much before the balance sheet reflects potential losses. Rebuilding capital buffers in resolution may not be enough on its own to restore confidence. Authorities must make further progress on how quickly banks heading into resolution could get liquidity support, such as by prepositioning collateral as well as testing preparedness, while at the same time protecting central bank balance sheets.
Authorities in numerous countries require strengthening deposit insurance regimes, as is recommended in Switzerland. New tech such as 24/7 payments, mobile banking, and social media, have increased deposit runs. 2023 failures entailed rapid deposit withdrawals, and the deposit insurers as well as other authorities should be ready and able to act more quickly than they currently can. The US banks that went on to fail were outliers with balance sheets that had grown very rapidly, funded due to a high degree of uninsured deposits. Where broader coverage is indeed being considered, it would need to be adequately funded. Especially in countries with deposit insurance that is not backed by a sovereign with deep pockets, policymakers have to be careful not to overextend deposit insurance coverage. If they aren’t backed by a commensurate rise in deposit insurance funding, depositors can go ahead and quickly lose confidence.
The bottom line happens to be that progress has been made, but there is still further to go in putting a stop to the too-big-to-fail kind of term. The bank failures of 2023 provided a valuable check on the growth that policymakers are making on the reform agenda and set a path for the leftover ground to be covered.
IMF staff happen to be working actively so as to support efforts in member countries to make their supervision, resolution, liquidity assistance, and deposit insurance frameworks more robust by way of FSAPs, technical assistance. One is also contributing to policy formulation at a global level, such as the recently announced review of international deposit insurance standards, as well as earlier this year hosting with the Financial Stability Board a workshop for policymakers in terms of transfer powers in resolution.
