Too important to fail

The Treasury Select Committee was on particularly supine form when half of the Monetary Policy Committee came to give evidence this morning. There was lots of discussion about banking regulation. Mervyn King, Bank governor, and Paul Tucker, his deputy, agreed that it is imperative for market disciplines to operate and no bank should be “too important to fail”.

John McFall, the committee chair, thanked them for this evidence, commenting that it was useful to hear such consistent views in contrast to press reports, which had suggested that there were differences between the two. He was perfectly justified in not believing everything he reads in the press, but in failing to probe any deeper, he completely missed the point.

No one at the Bank I know thinks it is OK for banks to be too important to fail. I also don’t know of anyone in official circles around the world who thinks this because it is evidently a stupid position to hold.

Mr King said this morning that there were some officials from other countries who did not understand the problem of “too important to fail”. As usual, he did not name them and the Bank has yet to come back to me on who they are.

But lots of sensible people, including the Treasury, believe that it is impossible to design a modern banking system in which you can guarantee that failures can and will happen without a state bailout. They also believe that splitting banks up would not greatly reduce the risk of a state bailout. The best we might be able to do is get to a situation where there is sufficient ambiguity over whether a government would rescue a bank that its management decide not to take absurd risks.

That is why there is consideration of living wills and even capital as a last resort, funded by the banking system.

The difference between Mr King and Mr Tucker is over what they believe is the best way to address the “too important to fail” problem, not that it is at the centre of the problem.

Mr King is keener on structural remedies and splitting banks up, though this morning he modified his position a little, acknowledging that other approaches might also work. Mr Tucker is keener on living wills “allowing banks and dealers to fail in an orderly way”.

The two positions are not mutually exclusive. But the difference is important because the authorities really need to decide whether most effort will be spent trying to change the structure of living banks such that they can be allowed to fail, or whether effort is better directed to drawing up emergency plans for banks’ failure in a future crisis.

What there is no doubt about is that there are big differences within the Bank of England about what to do about the “too important to fail” issue.

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