New global rules to prevent banks that are “too big to fail” from being bailed out by taxpayers have been proposed by the Financial Stability Board (FSB). Mark Carney, FSB chairman and governor of the Bank of England, told the BBC the plans were a “watershed” moment.
He said it had been “totally unfair” for taxpayers to bail out banks after the financial crisis of 2008 and 2009.
“The banks and their shareholders and their creditors got the benefit when things went well, but when they went wrong the British public and subsequent generations picked up the bill – and that’s going to end”.
He explained that the proposed rules will require big banks to hold much more money against losses and this would ensure that bank shareholders, and lenders to banks such as bondholders, would become first in line to bear the brunt of future losses if banks could not pay out of their own resources.
“Instead of having the public, governments, [and] the taxpayer rescue banks when things go wrong; the creditors of banks, the big institutions that hold the banks’ debt – not the depositors – will become the new shareholders of banks if banks make mistakes.”
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The rules proposed by the Financial Stability Board (FSB) are all about increasing how much capital the 30 ’globally systemically important’ banks have to hold. It’s about increasing the size of the airbag before they come to the taxpayer asking for money. It doesn’t affect the way money is created. It might slow down their money creation whilst they increase their capital, but in the long run it doesn’t change things. And if they choose the wrong level of capital for them to hold, then we still have to bail them out.
Currently, many banks are considered too big or too systemically important to fail. This is largely because of the costs to the economy of a large bank failing – in particular, the loss of deposits (i.e. money) – would not only be disastrous for the government that had to reimburse them, but also to the economy as panic spread from one bank to another causing a cascade of bank failures in the process.
Being ‘too big to fail’ means that banks can gamble with their customers’ money in the knowledge that the government will step in to cover any serious losses. This creates ‘moral hazard’ and encourages the banks to take greater risks in their investments: while one group stands to benefit if the bank is successful in its investments, another group (taxpayers) stands to lose if the bank is unsuccessful. As with deposit insurance, being too big to fail means banks can borrow at much lower rates than they would otherwise do (because lenders are not worried that their money won’t be repaid). This constitutes another subsidy.
In a reformed banking system, as proposed by Positive Money, taxpayers would never again have to bail out a bank. This would have the effect of removing a subsidy to the banking sector, as well as the added benefit that banks will be far more concerned with the types of loans they are making.
Because in the Positive Money system a customer making an investment would have explicitly agreed to accept the risks of the investment, there would be no need (nor a justifiable case) for the government to guarantee any investments. If a bank makes bad decisions and loses money, the customers who provided the money for those investments will lose money. In this situation the bank in question would be wound down, broken up and sold off. Borrowers would continue to pay off their loans (at the same rate as before) to whoever bought their loan contracts. This would be far easier and cheaper to do than under the existing system, for the following reasons:
The funds placed in Transaction Accounts would be 100% safe – the bank would not own their customers Transaction Accounts, nor would they appear on its balance sheets, and these would in any case be held separately from the bank’s Investments Accounts.
The taxpayer and government would have no exposure or responsibility whatsoever for the funds owed to holders of Investment Accounts. The Investment Account holders would become creditors of the liquidated bank, and insolvency law would govern whether and by how much they would be repaid their original investment.
That is not to say that all insolvent banks will go bust. In extreme cases the Bank of England could provide a temporary loan to a bank suffering from a short term liquidity issue. However, these loans should not be used to keep insolvent banks alive.