Banking and Finance Law Daily Wrap Up, DODD-FRANK ACT—St. Louis Fed examines methods to end the too big to fail problem, (Sep 30, 2013)
Organizations Mentioned:Federal Reserve Bank of St. Louis
By Stephanie K. Mann, J.D.
The Federal Reserve Bank of St. Louis has published two articles on the implications of the “Too Big to Fail (TBTF)” on the Dodd-Frank Act and an analysis of whether the single-point-of-entry will end the TBTF problem. The purpose of both articles is to determine what “will work” in order to establish a stable financial economy.
Implications on Dodd-Frank. In the first article, “On the ‘Too Big To Fail’ Debate: Implications of the Dodd-Frank Act,” the increased consolidation of the banking industry is of increasing concern due to the fact that the consolidated assets of the top 10 U.S. banks represent approximately 64 percent of U.S. banking assets. According to the article, the Dodd-Frank Act was passed to reduce the systemic risk that these large firms posed.
While it is unclear if Dodd-Frank “will work,” the article states that the Basel III capital reforms will go a long way in eliminating expecting bailouts by significantly reducing the likelihood of systemic firm failures and by greatly limiting the costs to society if failures do occur. In addition, Dodd-Frank has taken multiple steps to reduce the likelihood of system failure, including: the required resolution plans that firms must submit, enhanced prudential standards and requirements for central clearing of derivatives, capital is stress-tested on a regular basis, and the introduction of the single-point-of-entry concept. According to the article, the safeguards that have been introduced as a result of Dodd-Frank have already influenced a safer banking system.
Single-point-of-entry. In order to minimize the impact of a failure of a large financial institution, the St. Louis Fed examines the merits of the single-point-of-entry (SPOE) concept in the article “From Bailouts to Bail-ins: Will the Single-Point-of-Entry Concept End ‘Too Big To Fail’.” The SPOE strategy is a “bail-in” strategy because it implements a resolution process that imposes losses on shareholders and unsecured creditors and allows a systemically important financial institution to fail “without resorting to taxpayer-funded bailouts or a collapse of the financial system.”
Under the SPOE strategy, a financial institution, instead of bankruptcy, would be subject to the following procedures:
The FDIC would be appointed as the receiver of the institution’s top-tier holding company.
Assets of that holding company would be transferred to a bridge holding company, enabling domestic and foreign subsidiaries to remain open and operating.
Work would begin to transfer ownership of the bridge holding company to the private sector.
The subordinated debt, or even the senior unsecured debt, of the troubled firm would be used as the immediate source of capital for the new private-sector entity.
The remaining debt would be converted into equity claims that would also serve to capitalize the new private-sector entity.
The FDIC would provide assurances, as appropriate, that the ongoing operations of the firm and its attendant liabilities would be supported.
Ultimately, the credibility of the SPOE approach will not be known until it can be fully tested. However, it appears that the future remedies for handling troubled financial firms will focus on bailing-in the firm by imposing losses on shareholders and unsecured creditors, instead of bailing out firms by putting taxpayers at risk.
IndustryNews: CapitalBaselAccords DoddFrankAct FederalReserveSystem FinancialStability