One of the World's Too Big to Fail Banks Has Failed. Next?

Gary North

Nov. 21, 2011

Most people in the USA have not heard of the Dexia Bank. It was #49 in the world. Now it's busted. The Belgian government intervened to inject €4 billion into it to keep it from closing its doors.

We read on Wikipedia:

On July 15 the European Banking Authority, as part of its European bank stress tests, gave Dexia a clean bill of health, reporting that its tier 1 capital was 12.1 percent, and would fall to 10.4 percent in 2012 under its "adverse scenario". This would make it one of Europe's safest banks.

Dexia posted a €4 billion loss for the second quarter, the biggest in its history, after writing down the value of its Greek debt. On 4 October its shares fell 22% to €1.01 in Brussels, cutting its market value to €1.96 billion. Discussions were taking place about a possible breakup, with a plan to place its "legacy" division into a bad bank with government guarantees.

On 10 October, it was announced that the Belgian banking arm will be purchased for €4 billion by the Belgian federal government. Some units such as DenizBank and the Luxembourg retail bank will be put up for sale. Part of its French operations are likely to be purchased by Caisse des dépôts et consignations and La Banque Postale. The remaining troubled assets, including a €95 billion bond portfolio would remain in a "bad bank" that would receive funding guarantees of up to €90 billion provided by the governments of Belgium (60.5%), France (36.5%) and Luxembourg (3%).

In short, the experts at the agency in charge of monitoring bank safety never saw this coming.

On November 4, the G-20 nations' Financial Stability Board published a list of the banks in the world whose failure threaten the stability of financial markets. Dexia is on the list. But Dexia is gone. Apparently, the FSB did not get the memo.

The report begins as follows:

Policy Measures to Address

Systemically Important Financial Institutions

1. At recent Summits, G20 Leaders asked the FSB to develop a policy framework to address the systemic and moral hazard risks associated with systemically important financial institutions (SIFIs).

"Moral hazard" is the threat of a bank that takes extremely risky positions for high profits because its directors expect the government to bail it out if it gets hit with huge losses. This is called privatizing your profits but socializing your losses. That is what happened at Dexia.

2. In Seoul last year, G20 Leaders endorsed this framework and the timelines and processes for its implementation. The development of the critical policy measures that form the parts of this framework has now been completed. Implementation of these measures will begin from 2012. Full implementation is targeted for 2019.

Got that? Full implementation will be in 2012.

But Dexia is gone.

This is called locking the gate after the horse is gone. There are lots of horses. One of them is gone. This is 2011. The G20 leaders endorsed a timeline that is too slow.

3. SIFIs are financial institutions whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity. To avoid this outcome, authorities have all too frequently had no choice but to forestall the failure of such institutions through public solvency support. As underscored by this crisis, this has deleterious consequences for private incentives and for public finances.

4. Addressing the "too-big-to-fail" problem requires a multipronged and integrated set of policies. Accordingly, the policy measures we have agreed comprise:

i) A new international standard, as a point of reference for reform of our national resolution regimes, setting out the responsibilities, instruments and powers that all national resolution regimes should have to enable authorities to resolve failing financial firms in an orderly manner and without exposing the taxpayer to the risk of loss ('FSB Key Attributes of Effective Resolution Regimes');

ii) Requirements for resolvability assessments and for recovery and resolution planning for global systemically important financial institutions (G-SIFIs), and for the development of institution-specific cross-border cooperation agreements so that home and host authorities of G-SIFIs are better prepared for dealing with crises and have clarity on how to cooperate in a crisis;

Excuse me, gentlemen. Dexia is gone.

We are told that there must be more regulation. We are not told what agency will do the regulating. There is no such international regulatory body with the authority to impose meaningful sanctions.

iv) More intensive and effective supervision of all SIFIs, including through stronger supervisory mandates, resources and powers, and higher supervisory expectations for risk management functions, data aggregation capabilities, risk governance and internal controls.

In early 2012, stronger international standards for core financial market infrastructures will be finalised to reduce contagion risks when failures occur.

Of course, Dexia is gone. This means one fewer TBTF bank to monitor. This should make things easier.

6. Using the BCBS methodology, the FSB and BCBS have identified an initial group of 29 globally systemically important banks, listed in alphabetical order in the Annex to this document. These G-SIFIs will need to meet the resolution planning requirements by end-2012. National authorities may decide to extend these resolution planning requirements to other institutions in their jurisdictions.

Scratch that: 28.

7. The group of G-SIFIs will be updated annually and published by the FSB each November. The methodology and the data used by it will be publicly available so that markets and institutions can replicate the authorities' determination.

It really is a shame that the methodology failed to work earlier this year. We had such high hopes.

11. An FSB Peer Review Council, working with other bodies as appropriate, will review the full and consistent implementation of the G-SIFI measures and changes to national resolution regimes. The FSB, with the involvement of the IMF, the World Bank and the standard setters, will draw up a methodology to assess implementation of the Key Attributes standard.

12. The FSB and the BCBS will begin work this year to define the modalities to extend expeditiously the framework to all SIFIs. The International Association of Insurance Supervisors (IAIS) is expected to complete its assessment methodology for identifying globally systemically important insurers in time for the G20 Summit in June 2012. The IAIS will also pursue its work to develop a Common Framework for the Supervision of Internationally Active Insurance Groups by 2013, in order to foster group wide supervision and global convergence of regulatory and supervisory approaches.

We all hope that all of the other 28 will survive until June. It would be a shame to lose them before then, what with this great methodology almost ready for prime time!

Now we get to the list. Note: I have put U.S. banks in bold.

G-SIFIs For which the resolution-related requirements will need to be met by end-2012

Bank of America
Bank of China
Bank of New York Mellon
Banque Populaire CdE
Barclays
BNP Paribas
Citigroup
Commerzbank
Credit Suisse
Deutsche Bank
Dexia
Goldman Sachs
Group Crédit Agricole
HSBC
ING Bank
JP Morgan Chase
Lloyds Banking Group
Mitsubishi UFJ FG
Mizuho FG
Morgan Stanley
Nordea
Royal Bank of Scotland
Santander
Société Générale
State Street
Sumitomo Mitsui FG
UBS
Unicredit Group
Wells Fargo

We are treated to this: "Therefore, the list will not be fixed -- there can be new entries and exits every year and the number of G-SIFIs may change." That seems reasonable.

I wonder which bank will be moved up to replace Dexia.