Regulators' rhetoric about bank failures doesn't match their actions

Last month, the Federal Deposit Insurance Corp. published a paper entitled "Overview of Resolution Under Title II of the Dodd-Frank Act" on its website. It is most helpful as it explains how the FDIC interprets the untested U.S. bank resolution regime for big banks regulated in Title II (and, to some extent, Title I) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

At a video-recorded event on April 10 entitled "Addressing 'Too big to fail': FDIC update on orderly resolution of global systemically important banks," hosted by the Peterson Institute for International Economics, FDIC Chairman Martin Gruenberg explained that the agency was working on the paper well before the 2023 bank failures and that the purpose of the paper is similar to the Bank of England's "Purple Book" explaining the Bank of England's approach to bank resolution (first published ten years ago, most recently updated on Dec. 15).

This might explain, partly, why the FDIC paper does not reflect on the 2023 U.S. bank failures. In his speech, Gruenberg praised the FDIC's framework for big banks' resolution.

Gruenberg's comments did not acknowledge the manifest shortcomings of the FDIC's resolution framework. Following the global financial crisis of 2007-2008, bank-specific insolvency proceedings ("bank resolution") have been adopted in the U.S. and other G20 nations to prevent future taxpayer-funded bank bailouts. That framework has proven to be unworkable for political reasons, as shown by the 2016-2017 and 2023 European and U.S. bank bailouts. Yet, regulators insist on its overall appropriateness.

As a result, the post-crisis resolution strategy has not fulfilled its "no more bailouts" objective, and the actual measures taken by regulators have contributed to increased market concentration in the banking sector (fewer and bigger banks), along with greater public debt burdens, thereby impairing the ability of governments to deal with future financial crises.

Law and regulation

FDIC's Gruenberg: We have a strategy to fail a 'too big to fail' bank

April 10, 2024 12:37 PM

Despite financial regulators publishing these otherwise very helpful papers on their interpreting bank resolution rules, legal uncertainty remains in this area of financial regulation due to the discrepancies between the regulatory framework and the actual crisis management measures governments have been taking in the past years. See the regulatory responses to the 2016-17 and 2023 bank failures on both sides of the Atlantic.

Under crisis conditions, bank resolution requires governments to incur taxpayer-funded obligations to maintain the liquidity of the failing bank during the resolution process, even if some of those costs can be subsequently recovered from the banking industry. Financial crises are crises of confidence. Therefore, the primary goal of financial crisis management must be to restore public trust in banks.

As long as the primary goal of financial crisis management remains taxpayer protection, we cannot have an effective framework, and governments will continue spending even more on bank bailouts than before the 2007-2008 crisis.