Tuesday, 13 December 2011

Bank failure contingency plans

Contingency planning for bank failures sounds like a very uninteresting topic. Perhaps it is. But it’s pretty important, since all banks nearly failed (and some did) in 2008 and most seem quite vulnerable to deterioration in asset prices in light of a major recession/depression. Yet despite this, banks continue largely as they did before, with huge rewards to those in the financial industry.

The financial industry appears to me to have successfully operated to transfer huge amounts of wealth from governments, taxpayers, workers, pension funds, developing countries, banking shareholders, and so on, to the financial ‘talent’ and perhaps some very wealthy people. The financial ‘masters of the universe’ appeared all powerful both before and after the financial crash.

One suggestion is that the prospect of being bailed out leads to the moral hazard of a riskier culture within the banking industry. We heard about how the banks had to be saved in order to keep cash machines and cards working, in order for the economy to function. However, if banks are too important (let alone big) to fail, then there is a big moral hazard problem. I always assumed that governments had good contingency plans, but I haven’t heard anything about the one I am about to describe. I really hope it is in place, for reasons I will explain.

My hope is that the next time there is a banking crisis there will not automatically be a recapitalisation of the existing banks at taxpayer (or more accurately, government benefit recipient) expense. Instead, I think the bank should be allowed to fail, but in such a way that the depositors have a certain degree of security (as they do) and that they can access this security without any problems.

This seems relatively easy to achieve from the perspective of the government. They just have to have in the conditions of a retail bank that they should have certain rules in place in the case of failure of a bank group. Should such a failure occur, the bank should have a contingency plan in place whereby certain designated members of staff and the bank’s information transfer immediately to a new public body charged with the orderly break-up of the bank and maintenance of the card network. The break up and so on could take a while, as there would be many assets to unravel and sell, and creditors to pay. However, the system needs to keep working in the very short term at the street level.

To achieve this I propose that the following be done beforehand. The bank would have had to pre-designate each cash and credit card with an amount of ‘credit’ (like an overdraft) in such a situation. This amount would be revised as regularly as feasible to take account of the money available to each person. Then, if the bank were to collapse, the new public body would set up a new account for each person/account with that institution. People could then use this account—with a daily limit up—to its pre-determined limit. People would be eating into the guaranteed amount of their savings that are guaranteed by the government (currently limited to £50,000). But at least they would still be able to obtain cash and obtain their necessities.

Having this smooth contingency plan in place would mean that banks would have no leverage to demand a bail-out in order to stop total Armageddon on the streets. Banks would know that if they got in to trouble they would have to get themselves out of it, which would reduce the prospect that they would take too many risks (though I’m not totally convinced of this, if banks are acting—as they seem to be—in the interests of their ‘talent’ rather than their shareholders).

One important difference between this approach and the bail-out approach is that the bank staff would work at a civil service approved wage. In 2008, bankers continued to get their huge incomes and even bonuses, supported by taxpayers, and there was nothing anyone could do about it. However, the new public body I propose would not have to honour the contracts of workers with the old company. Some would be retained, but on new temporary civil service terms. This would not only serve to incentivise shareholders to avoid risk-taking, but also the decision makers (referred to above as the ‘talent’), as they would face the loss of their contract in the event of bank failure.

Perhaps such rules are in place, but I don’t know about them. Could anyone enlighten me? Or explain why this is a bad idea?

No comments:

Post a Comment