Wednesday, July 8, 2020
Yesterday, Randal K. Quarles, the Vice Chair of the Board of Governors of the Federal Reserve System and Chair of the Financial Stability Board (FSB), gave a speech at the Exchequer Club entitled “Global in Life and Orderly in Death: Post-Crisis Reforms and the Too-Big-to-Fail Question” (here). As he notes, the catchy first part of this title harkens back to the 2010 words of Mervyn King, then Governor of the Bank of England, who stated that “most large complex financial institutions are global—at least in life if not in death.” Quarles asserts that “In this pithy sentence, he [King] summed up the challenge policymakers faced.”
The context of Quarles’ speech is the FSB’s recent consultation report: Evaluation of the effects of too-big-to-fail reforms (here). Two major challenges post-crisis banking reforms sought to address were: 1) the market’s assumption that big banks would not be allowed to fail, and the moral hazard this created, and 2) the absence of effective resolution frameworks for global banks, which lead to bank rescues. There’s lots of good news here, including that prior to the current crisis, globally systemically important bank capital ratios had doubled since 2011 to 14%. As a result of this and other reforms, such banks have fared much better in the current crisis, and “[t]his has allowed the banking system to absorb rather than amplify the current macroeconomic shock.” Good news indeed!
At the same time, the challenges of the current crisis are not over. The International Monetary Fund projects that the global economy will contract by 4.9% in 2020 (a steeper decline than with the 2007-08 financial crisis). And Quarles notes that “The corporate sector entered the crisis with high levels of debt and has necessarily borrowed more during the event. And many households are facing bleak employment prospects. The next phase will inevitably involve an increase in non-performing loans and provisions as demand falls and some borrowers fail.”
Corporate and consumer bankruptcies are almost certain to increase as a result of the current crisis. Should a wave of such bankruptcies materialize, this could lead not only to a broader financial crisis, but also to the overwhelming of bankruptcy courts, including a need for additional bankruptcy judges (here). In the U.K., banks have been told to “rethink handling of crisis debt” (here), and the need for related, effective dispute resolution systems has also been noted.
Once again, the necessity of effective resolution frameworks is likely to be front and center in banking regulation. However, this time, it is likely to be a need for effective dispute resolution frameworks so that banks can speedily deal with consumer and corporate bankruptcies to promote economic recovery.