State-free bank safety net still work in progress-regulators

Wed Mar 13, 2013 2:04pm GMT

* "Too big to fail" will take years to resolve

* Balkanisation of a markets a growing side effect

* Worries about costs to economy, competition as well

* Agreement on bail-in debt seen as key

By Huw Jones

LONDON, March 13 (Reuters) - Reforms to the world's financial system still fall short of ensuring that big and systemically important banks will not need to be bailed out by governments if they fail, regulators say.

Tougher capital rules have helped to reduce taxpayer exposure to future rescues.

But the biggest lenders - some with assets bigger than the economies of many countries - remain "too big to fail", a phrase used to describe those that could not be allowed to go under because of the wider impact on global finance.

There is significant work still to do, regulators say, despite the efforts made since the 2007 financial crisis and the subsequent bank bailouts.

"We are 70 percent of the way through the process of putting those structures in place," Adair Turner, chairman of Britain's Financial Services Authority, told Reuters.

"Once we have done that we will hugely reduce the probability that we will have to, in any future crisis, put in any public money," Turner said.

Turner says the key step to ending "too big to fail" is the ability to impose losses on bank bondholders, known as bailing in, but that this is likely to take years to introduce.

The principle is agreed globally, but there are splits in the EU over whether it should apply to senior as well as junior debt, or if there should be a new category of bail-inable debt.

And in the absence of a guaranteed system for winding banks down without causing market mayhem, taxpayers could be stuck with helping troubled banks for many years to come.

"It is difficult to see any major systemically important financial institution being allowed to go under," said Manmohan Singh, a senior economist at the International Monetary Fund.

The European Union is in the process of approving a draft law forcing regulators to coordinate cross-border rescue efforts, but this is complicated by many big lenders having their head office outside the bloc.

Regulatory hardliners point out that the EU draft still gives governments the option to rescue a bank.

Bank of England (BoE) Governor Mervyn King says that the success of global resolution regimes will depend on close cooperation between supervisors, something that organisations such as the British Bankers Association (BBA) believe is unlikely to be strong enough to overcome lack of trust among them in a crisis.

Athough the BoE and the U.S. FDIC regulator have agreed to coordinate on so-called resolutions, this lacks legal backing.

"Resolution of cross-border banks is a long term goal that is 10 to 15 years away," Etay Katz, a lawyer at Allen & Overy specialising in financial services, said.

DISTORTION

Without a resolution system in place, regulators and analysts say that the perception of a guarantee for major banks distorts competition and undermines the global economy.

Banks enjoy higher credit ratings and therefore cheaper borrowing costs, a subsidy the BoE says is worth 30-50 billion pounds a year just for the UK's top five lenders.

With little prospect of binding rules, many supervisors are playing it safe by forcing operations of foreign banks on their turf to hold local capital and cash buffers.

Morgan Stanley banks analyst Huw van Steenis said this "balkanisation" of banking markets acts as a drag on lending, economic recovery and could be a source of instability.

Euro zone banks went from providing 40 percent of all Asian large ticket trade finance in early 2011 to just 3 percent in 2012 as they reduced their lending outside core markets.

"As long as we have a system where we can't resolve large banks with cross-border operations and as long as there isn't the system to counter that, then the trend towards Balkanisation... will not go off the table," Britain's top banking supervisor Andrew Bailey said.

But such moves may also have their benefits.

"Today it's the subsidiaries that are helping to shore up the capital base of the parent banks," former Mexico central bank governor Guillermo Ortiz, who is now chairman of Mexican bank Banorte, told Reuters.

Regulators now talk of a race between those that want to fragment the financial system until "too big to fail" is overcome and those who want to preserve the benefits of a global system with large systemically important banks.

"Bank resolution is the battleground for that race," a central banker said on condition of anonymity.

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