10/12/2012 07:20 GMT | Updated 10/12/2012 07:24 GMT

New UK Banking Regulations Could End Tax-Payer Bailouts For Banks

The Bank of England has issued a joint paper with the US's Federal Deposit Insurance Corporation which is designed to lessen the impact of financial institutions going into difficulty on the public's purse.

Among the key recommendations are for there to be one super regulator which will oversee the parent company of the bank or other institution if and when it needs restructuring, or if a part of it struggles with insolvency and recovery issues.

The report also suggests that in the event of financial difficulties, a bail-in strategy would see creditors at the top of the group write off their losses or convert them into equity and become shareholders - which would lessen the obligation on the public purse for tax-payer funded bailouts.

Under the report's proposals, any equity and debt would be transferred from the shareholders and debt holders to an appointed trustee. The trustee would then hold the securities while the extent of the losses expected to be incurred and the recapitalisation amount is established. During this period, listing of the company’s equity securities (and potentially debt securities) would be suspended.

The new practices would also limit bank arms operating overseas from impacting on their parent companies - the report's aims are designed to ensure that sound business, including all operating companies can be kept open and operating, limiting the effect on financial stability through contagion effects and cross-border complications.

Paul Tucker, deputy governor for financial stability at the Bank of England, said in a statement accompanying the report: "The 'too big to fail' problem simply must be cured. We believe it can be and that this joint paper provides evidence of the serious progress that is being made."

Sounds good, erm, doesn't it?

In the UK, the current Banking Act provides the Bank of England with tools for resolving failing deposit-taking banks and building societies, such as transferring all or part of a failed bank's business to a private sector buyer (or to a bridge bank until a private buyer can be found) and providing an insolvency procedure which protects insured depositors while liquidating a failed bank's assets.

These powers have helped in the case of solely domestic banks but when it comes to large and complex international financial firms, the basic functions which allow a bank to operate are intertwined legally and financially across international jurisdictions.

Therefore, to use the current banking laws, the Bank of England would have to separate and transfer businesses from within the parent company to a buyer or bridge bank, while leaving behind the remaining liabilities and bad assets in the failed firm to be wound up through insolvency - a task which is almost impossible to do without destroying the value of the bigger company.

Among the concerns of banking experts are whether creditors and investors in financial institutions would be willing to become shareholders in the event of another banking crisis - the Association of British Insurers has already highlighted that investors are increasingly finding UK financials less attractive.

The ABI is due to deliver a report to the Parliamentary Commission on Banking Standards on behalf of its members, who control £1.5 trillion assets and are among the bank's biggest investors, which will say investors are concerned that other regulations being introduced to shore up financial stability are putting economic growth at risk.

"This has a negative impact on banks' investability," the ABI told the commission.

"The prospects of sustainable economic recovery in the UK are to some extent dependent on banks being able to raise the funds necessary to finance the growth of small and medium-sized companies. From the perspective of institutional investors, it is essential that banks should be an investable proposition."

In particular, the Vickers Report recommendation to split up the retail and investment parts of the bank entirely is not proving popular with ABI members, as they are "far are unconvinced about the real benefits of ringfencing and/or separation and are sceptical about the benefits relative to the operational costs and disruption".

In addition, banks' balance sheets are notoriously difficult to gain transparency on. Speaking to the Huffington Post UK in November, Company Watch's analyst Nick Hood explained that since the capital adequacy of banks was driven by so many factors, nobody can put an accurate number their current deficits.

"A blindfolded monkey with a pin has as good a chance of getting the figure right as any hypothetical financial model," he said.

Expert reaction

Chris Cummings, chief executive of TheCityUK - a lobbying organisation for the city of London and its businesses, told Huff Post UK that anything that saw greater cooperation between international regulators was a good thing.

"Following the financial crisis, it's right for regulators to reflect on the needs of the voters - the challenge will be to make sure they regulation is introduced in a way that isn't at the expense of economic growth," he said.

Ismail Ertürk, senior lecturer in banking at Manchester Business School, told Huff Post UK having a single regulator to oversee international parent banks "won't work".

"Technocratic regulators should be guided by the society's democratic choices. The question is what social and economic value the society will get from large complex banking institutions.

"The evidence so far since the crisis shows regulators and even the top management in the banks have no clue what is going on at trading desks; look at the Libor scandal, UBS trader's fraudulent losses, J P Morgan Chase's big whale's losses, mis-selling at retail banks etc.

"We need simpler finance and banking that serves economic and social needs. Large complex banks serve only bankers themselves."

Roger Doig, credit analyst at Schroders, agreed: "The problems with the approaches – that UK banks still face damaging runs by corporate depositors, banks operating through overseas branches may lack credibility with foreign counterparties of those branches, and lead regulators may not act in a sufficiently timely manner to prevent loss of confidence in overseas subsidiaries, among other things – all remain."

On the report's recommendation for banks to hold more capital to allow them to restructure if needed, Ertürk foresaw problems given that almost all banks are at the moment subsidised through quantitative easing policies, bond buying policies of central banks in the US, EU and UK and are unable to operate without such subsidies.

Cummings suggested that the Financial Service Authority's recent round of stress testing should reassure investors that banks are a good bet - but SCM Private's chief investment officer Alan Miller disagreed.

adair turner

Adair Turner, current FSA chairman, has already been grilled for his handling of the financial crisis by MPs

"When it comes to financial regulation, the US is miles ahead of the UK. If you look at the 'special administration' of MF Global (a large international bank which fell into administration in 2011) you can see that the FSA has been spectacularly unsuccessful compared to other jurisdictions' regulators.

"In Canada, shareholders in MF Global have received all 100 pence in every pound they invested, in the US, they've got 76 pence in every pound. More than year after MF Global failed, UK investors are yet to get more than 26 pence in every pound invested."

And the suggestion of insulating foreign arms and ensuring they have access to their own capital and cash ring-fenced away from the main operation is not realistic, according to Ertürk.

"It is not possible to act in such a way because such ideas totally ignore the way banks are interconnected; stopping one activity will cause huge systemic consequences. We need to focus on a regulation that regulates the activities of banks and that does not allow socially harmful activities that are designed to generate bonuses without solving bank customers' needs.

"Banking does not need to be a complicated business carried out by large complex institutions. No matter how much capital they have if there is a systemic failure they will all turn to taxpayers to save them."

Cummings added: "In this globally interconnected world, we've gained a range of financial products and services which have been made available (thanks to the interconnectivity) - if there's a desire to regionalise operations, that comes with a concern that we may be limiting the products and services we can offer in the UK."