“A British bank is run with precision
A British home requires nothing less
Tradition, discipline and rules
Must be the tools
Without them: disorder, catastrophe, anarchy
In short, you have a ghastly mess!”
George Banks and chorus in ‘Mary Poppins’
Mary Poppins, as every adult knows, is about banking not childcare.
For financial aficionados the Mary Poppins dramatic force hinges around the run on the fictional Fidelity Fiduciary Bank (officially, the ‘Dawes, Tomes, Mousely, Grubbs Fidelity Fiduciary Bank’) rather than house-keeping issues.
Apologies for the spoiler but the Fidelity Fiduciary Bank capital buffers prove inadequate against the loss of customer confidence sparked by a single child demanding the return of his coins.
At the time of its release in 1964 and for decades to follow, the Mary Poppins bank run would have appeared a more fanciful plot device than accurate depiction of real life – in Britain at least. But in 2007 the Fidelity Fiduciary mayhem depicted in the Academy Award-winning movie was mirrored in reality as customers queued on UK streets to close accounts at the failing Northern Rock bank.
Northern Rock was eventually bailed-out but the spectre of bank failure, brought into sharp focus across the world at the height of the global financial crisis (GFC), triggered huge taxpayer-funded banking rescue missions in many jurisdictions.
As explored in previous Fiorinos, post-crisis governments globally determined to ward off future bailouts with a series of measures designed to shore-up bank capital adequacy and set new procedures for managing financial institutional failures in a manner that more fairly apportioned risk.
Regulators dusted-off the antiquated notion of ‘resolution’ to describe the new method for tackling bank runs.
Resolution regimes set the procedure for failing banks to be sold or close without disrupting the wider financial system or leaving taxpayers on the hook. As well, the bank resolution rules respect the hierarchy of liquidation claims by allowing shareholders and unsecured and uninsured creditors to absorb losses as per well-defined protocols.
In the aftermath of the GFC, investors, as well as regulators, have been forced to take into account the real prospect of bank failures when assessing risks. The so-called ‘Doomsday Argument’ (DA), first laid out in formal statistical language by astrophysicist Brandon Carter in 1983, offers another gloomy view on the odds of future bank runs.
Essentially, Carter suggested it was possible to predict the number of humans who will ever live by estimating the number of people who have ever been alive to date. According to some versions of the DA postulate, given the human race has produced about 100 billion individuals to date, probability theory suggests the species is about midway through its run, leaving us a miserly 1,000 years or so of existence.
Of course, the DA methodology does not apply exactly to assessing the risk of bank failures. However, the Carter theory does invite analysts to consider future bank runs as possible events instead of impossibilities.
US v Europe: resolving the differences
In the US the Dodd-Frank Act (DFA) is the key legislative instrument governing the country’s banking system. The DFA is split between Title 1 (oversight of large financial institutions) and Title 2 (resolution powers).
Banks in Europe, however, fall under different measures covered in state aid rules and the Bank Recovery and Resolution Directive (BRRD). The BRRD provides an overarching framework to ensure troubled financial firms can be repaired or resolved without public money.
Both DFA and BRRD share a common emphasis on financial stability along with setting similar conditions for opening resolution proceedings and defining administrative powers. Nonetheless, there are important differences between the two regimes, notably the lack of a restructuring option in the US or the latitude surrounding precautionary recapitalisation measure in the EU.
The DFA specifies three cumulative conditions for starting a resolution:
- the restructuring of the failing firm through contractual arrangements is not possible;
- the application of corporate insolvency law would lead to economic inefficiencies; and,
- the bankruptcy of the financial institution could endanger financial stability.
Ranking first, ‘contractual arrangements’ refers to resolving or restructuring a bank via the private sector. Instruments such as contingent convertible bonds – or ‘CoCo’ – can offer a private sector exit route for troubled banks by transforming debt into equity.