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Counteracting the domino effect

Wednesday 12 May 2010 - by Edmund Lakin

Global regulators are united in their view that the failure of individual financial institutions must never again be allowed to bring the economy to its knees. Edmund Lakin examines the options on the table

The interconnectedness of financial institutions may once have been perceived as a strength of the global economy but following the financial crisis, the opposite became apparent.

Financial market integration and development had been seen to be an enhancer of financial stability through the creation of deeper, broader, more liquid and competitive markets but the interconnectedness also increased financial instability.

The policy debate has since focused on ensuring that future crises are managed effectively in their wake, but also that effective preventative measures are developed.

From a policy point of view the problems with current crisis management arrangements have been widely recognised and proposals for reform are being made. Lessons drawn from high profile failures have focused on group structure, liquidity, and information sharing concerns.

A considerable amount of work has already been undertaken by both the International Monetary Fund and the Basel Committee on Banking Supervision, with more expected. A large part of the recent work has been driven by the G20 who made it clear in their September Pittsburgh Communiqué that they sought more powerful tools to hold large firms to account for the risks they took and wished to develop tools and frameworks for the effective resolution of financial groups.



An original overview of the legal, institutional and regulatory framework for bank insolvency was set out by the IMF, along with the World Bank, back in April 2009. They recommended that in crises the framework should allow for a flexible response aiming to protect payment systems, limit the loss of depositor and creditor confidence, and restore bank solvency, liquidity and stability.

The IMF, at the request of the G20, is currently preparing another paper addressing issues relevant to cross-border bank resolution. In March, the BCBS issued final recommendations for strengthening cross-border bank resolution frameworks. These recommendations were formed on the basis that many countries lacked appropriate resolution tools, and that many actions taken were ad hoc and involved a significant amount of public support.


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