Plosser warns US regulations could cause unnecessary bail-outs

Charles Plosser, the Federal Reserve Bank of Philadelphia president, last week criticised US efforts to end the too-big-to-fail problem and advocated a more rules-based approach to bank resolution.

“Can we end too-big-to-fail? I think we can, but I believe the current efforts may come up short,” he said.

The Dodd-Frank Act, under Title II, provides a framework for the Federal Deposit Insurance Corporation (FDIC) to act as a receiver and carry out the liquidation of failing banks, including systemically important financial institutions (Sifis).

“While Title II improves our ability to wind down Sifis, it affords substantial discretion to regulators, which I see as a serious drawback,” Plosser said.

He raised concerns that the element of subjectivity could result in some bailouts being wrongly granted, while others could suffer delays at a result of the complicated procedures involved.

“By unleashing the FDIC’s wide range of discretionary powers, the mechanism may lead to bailouts that are unnecessary or to rewarding certain creditors at the expense of others,” he said.

“Worse, these decisions might be made in an arbitrary manner that is inconsistent with the rules of priority. On the other hand, the complicated procedure for invoking the FDIC’s Title II authority may lead to excessive delay.”

He concluded that, in any case. The Title II framework “is likely to be biased toward bail-outs”.

Plosser noted that it also provides an incentive to “game the system”, as the framework is only applied when there are concerns about a failing companies systemic impact. Therefore, it is in their interest to take actions “that would place them in the category of firms that would receive a bail-out”.

In place of Title II, Plosser called for a “more systematic and rule-like” approach that effectively eliminates the potential for bail-outs.

This would take the form of a bankruptcy mechanism applicable to all financial institutions, regardless of systemic importance, where a “specialised federal judge” would oversee the resolution process.

Plosser also called for a simpler and more transparent approach to reducing the probability of a financial institution failing in the first place.

He also called for the simplification of capital regulation and either a reduction or total elimination of the “ever-increasing complexity of risk-weighted capital calculations”.

“The Basel II and III emphasis on risk-weighted capital as the primary measure of capital adequacy should be seriously reconsidered, with more emphasis on the simple leverage ratio,” he said.

 

This article was first published on Risk

 

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