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University of Zurich Forum Can Banking and a Market Economy Co-exist? or “Is There Enlightened Banking?”. Wilson Ervin Senior Advisor/ Former CRO Credit Suisse AG January, 2012. A Triangle of Participants. Individuals. Banks. The State. Financial Crisis: a Triangle in Trouble.

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Wilson Ervin Senior Advisor/ Former CRO Credit Suisse AG January, 2012

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Wilson ervin senior advisor former cro credit suisse ag january 2012

University of Zurich Forum

Can Banking and a Market Economy Co-exist?

or “Is There Enlightened Banking?”

Wilson Ervin

Senior Advisor/ Former CRO

Credit Suisse AG

January, 2012


A triangle of participants

A Triangle of Participants

Individuals

Banks

The State


Financial crisis a triangle in trouble

Financial Crisis: a Triangle in Trouble

Individuals

Disruption of finance

severe recession

Banks

The State

Bail-outs

Contagion, systemic risk


Many many many proposals to fix the problem

Many, many, many proposals to “fix the problem”

Basel 2.5, Basel 3

Core Capital/ Hybrids

Contingent Capital

Gross Leverage

Size Restrictions

Central Clearing

Derivatives Transparency

CDS regulation / ban

Dark Pools

Shadow Banking

Bank Resolution

Bubble Busting

Systemic Regulators

Regulator Shopping

Consumer Protection

Compensation

Board Governance

Repo Reform

Procyclicality

Rehypothecation

Money market funds

Liquidity Regulations

Lifeboats

Ring Fencing

Subsidiarization

Volcker Rule

Glass – Steagall II

Narrow Banking

MtM Accounting

Bonus Taxes

Bank Taxes

Transaction Taxes

. . . and . . . and . . .


But one reform is central solving too big to fail

But one reform is central: solving “Too Big To Fail”

Basel 2.5, Basel 3

Core Capital/ Hybrids

Contingent Capital

Gross Leverage

Size Restrictions

Central Clearing

Derivatives Transparency

CDS regulation / ban

Dark Pools

Shadow Banking

Bank Resolution

Bubble Busting

Systemic Regulators

Regulator Shopping

Consumer Protection

Compensation

Board Governance

Repo Reform

Procyclicality

Rehypothecation

Money market funds

Liquidity Regulations

Lifeboats

Ring Fencing

Subsidiarization

Volcker Rule

Glass – Steagall II

Narrow Banking

MtM Accounting

Bonus Taxes

Bank Taxes

Transaction Taxes

. . . and . . . and . . .

  • “Addressing the problem of ‘too big to fail’ is the next central step in the reform program”

    Mario Draghi

  • “If the crisis has a single lesson, it is that the ‘too big to fail’ problem must be solved”

    Ben Bernanke


Wilson ervin senior advisor former cro credit suisse ag january 2012

  • Can we fix

  • “Too Big To Fail?”


Defining success

Individuals

Defining Success

State

Banks

  • Resolution Authority Objectives:

    • “preserve operations that provide vital services”

    • “avoid unnecessary loss of value and contagion”

    • “ensure losses are borne by shareholders & unsecured creditors – not taxpayers”


How to do it

How To Do It?

  • FSB Resolution Tools:

    • Sale of firm

    • Create bridge bank for critical functions; wind down remainder

    • Recapitalize bank by restructuring liabilities: “Bail-in Within Resolution”

  • Bail-in Within Resolution

    • A high-speed, pre-wired, forced recapitalization of the bank

    • No government capital at risk – not a bail-out

    • All systemic functions and customer activities continue as normal

    • No need for (difficult) emergency restructuring of businesses

    • Going concern approach preserves franchise value for creditors


Bail in an example

Bail-in – an example

Old Balance Sheet New Balance Sheet

  • $600 bn assets  $575 bn (i.e. $25 bn write-down)

  • ---------------- ---------------

  • $430 bn “franchise” liabilities  No change – remains at par

  • (deposits, retail, swaps, payables)

  • $120bn senior debt  15% new equity (85% unchanged)

  • $ 25bn preferred & sub debt  new equity

  • $ 25bn equity  write-off or warrants

  • Equivalent to a high-speed recapitalization for banks

    • “NewCo” now well capitalized (well-priced assets and $43 bn fresh capital)

    • No government capital at risk

    • Customer activities continue as normal – going concern


Example impact on the system

Example –Impact on the System

Actual LehmanBail-in Pro Forma

  • Equity wipe out warrants

  • Sub debt wipe out shares

  • Senior debt10% to 25% recovery ~par (85% + shares)

    Investor Impact~$150bn of loss ~ $25 bn loss

    (= 5x - 6x asset loss) (= 1x asset loss)

  • Customers*: large losses no loss

  • Counterparties*: large losses no loss

  • Markets: massive unwinds relief rally?

    • & deleveraging

  • Know Result? up to 10 years now

Low “run”

pressure


Wilson ervin senior advisor former cro credit suisse ag january 2012

The tough technical questions:

  • Bank scope – SIFI’s only? G-SIFI’s? or broader?

  • Trigger choice – who pulls and under what rules?

  • Instrument scope – which instruments? (esp. derivatives? short term funding?)

  • Protocol – constructive ambiguity? or transparent rules?

  • Inter-creditor rules – how to balance different classes fairly

    • Sequencing and method of valuation write-downs

    • Write-off vs dilution, and order of application

    • Strict vs graduated priority?

  • Will investors buy and at what cost?

  • Feedback effects? (e.g. runs, arbitrage)

  • Need and structure of liquidity support?

  • Execution issues. Capacity to handle multiple events?

  • Impact on systemic stress?

  • Grandfathering / Transition?

  • Safeguards & governance

  • Treatment of groups & legal entities

  • Cross border implementation

  • Cross border execution / ring fencing

A serious “to do” list

but solvable & finite

Legal elements


What about systemic implications

What about systemic implications

  • Lowers Contagion:

  • No losses for “franchise counterparties”

  • No losses for retail clients - reduced pressure for “runs”

  • Reduces losses dramatically for long term investors

  • Less Pressure on Financial System:

  • Doesn’t “push the problem” to other banks (mergers) or into troubled markets

  • Creates new equity where needed

  • Doesn’t create ever bigger banks

  • Other Implications:

  • Relative simplicity - easier to execute

  • More predictable & transparent

  • Eliminates pressure on sovereign credit

  • Avoids unstable “beggar thy neighbor” – globally constructive


Bail in a sustainable and powerful approach

Bail-in: A sustainable and powerful approach

  • Make resolution “practical” via going concern approach

    • Not a taxpayer bail-out – use a bank’s own capital

    • Protect deposits & key activities – remove path of contagion & runs

  • Practical and effective with today’s banks

    • Good backtesting results for all recent major bank events

    • Access a huge pool of capital - can handle crises bigger than 2008

    • Works internationally – doesn’t “export the problem”

  • Improve outcomes for real economy; lower systemic stress

    • Creates new equity for the system – avoid “deleveraging cycle”

    • Better market signals to help discipline behavior

    • Reduces pressure on government finances


A global issue where are we now

A global issue: where are we now?


Regulatory developments switzerland and usa

Regulatory Developments – Switzerland and USA

  • Pioneered many elements of bank resolution, including bail-in concepts

  • Existing law

  • Expert Commission (2010)

    • Emphasis on strong capital & protection of domestic functions

    • Innovative use of Contingent Capital as part of capital

  • Ongoing development of Ordinances / Consultations

  • Dodd Frank (2010) – legal basis for “Orderly Liquidation Authority”

  • Bail-in Within Resolution also permitted under law

  • FDIC stance evolving from “orderly liquidation” to “recapitalization”

  • Economist Roundtable (Dec. 2011): unanimous preference for bail-in


Regulatory developments europe

Regulatory Developments - Europe

  • In practice, such a [bail-in] tool might be most useful in the case of systemically important institutions which are considered to be “too big to fail’, or in a generalized situation of stress where there is unlikely to be a large pool of potential 3rd party purchasers.

European Commission

DG Internal Market and Services (January, 2011)

Most persuasively, if the social cost of a systemically important bank going into insolvency is intolerable, there needs to be some mechanism for imposing losses on liabilities in resolution (otherwise they benefit from a government guarantee). This by definition is what bail-in provides.

. . . the authorities should have a ‘primary bail-in power’. . . to write down liabilities to recapitalise a bank (or part thereof) in resolution.

Final Report, September 2011


Global momentum

Global Momentum

The new standard will address the “too-big-to-fail” problem by making it possible to resolve any financial institution in an orderly manner and without exposing the taxpayer to the risk of loss . . . endorsed by the G20 Leaders . . . require jurisdictions to resolve a financial institution that is no longer viable, including through transfers of business and creditor - financed recapitalisation (“bail-in” within resolution), that allocate losses to shareholders and unsecured and uninsured creditors in their order of seniority

“Key Attributes of Effective Resolution Regimes for Financial Institutions”

G-20 Summit: October 2011

Bank Associations:


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