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24 September, 2011Emerging Markets, September 2011
A major fund manager says he expects a 25% shrinkage in the developed world’s banking systems, as market turmoil increases pressure on an already beleaguered financial sector.
“The financial system has to shrink,” said Peter Fisher, Senior Managing Director of BlackRock, which had $3.66 trillion of assets under management as of June 30. “We want to inject more capital into it to make individual firms stronger, but the system is too large, and my guesstimate is 25% shrinkage in North America and Europe.”
Global banking is in a perilous state. The International Monetary Fund this week calculated that the euro area sovereign credit strain had had a direct impact of around Eu200 billion on banks in the European Union since the outbreak of the sovereign debt crisis in 2010. The European Central Bank has had to lend to banks struggling to borrow in private markets, and downgrades have taken place on both sides of the Atlantic, most recently for Citi, Wells Fargo and Bank of America earlier this week.
The strain is already prompting bankers, fund managers and policymakers to consider how the next bank failures should be resolved, with a range of different opinions on whether any banks should be considered too big to fail, and what the role of the taxpayer should be in any subsequent restructuring.
Thomas Huertas, a member of the executive committee of the UK’s Financial Services Authority, said that previous methods of failed bank resolution had to be changed. “Better resolution is the key to financial stability,” he said. “Old methods don’t work. New ones are needed. Bankruptcy does not work for banks.” Bankruptcy for banks was tantamount to liquidation, he said, with severe impacts on creditors, financial markets and the economy. “Repeating Lehman is not a good idea,” he said. “Nor, in our view, is continuing ‘too big to fail’. This is a policy too costly to continue.”
Huertas called for a “middle way, to resolve failing banks without putting them into liquidation and without taxpayer support.”
His call was challenged by Peter Fisher, senior managing director of Blackrock. “Something that concerns me greatly is whether we can really achieve a point where a major institution may be resolved without any recourse to taxpayer support,” he said. “I know that’s a consummation devoutly to be wished. But at the same time, it doesn’t seem to be practical to both do that, and address ‘too big to fail’. If we round to zero the likelihood the authorities ever have to reach into their own pocket, we will have created a class of institution that can never fail.”
In particular, he said, seeking capital to shore up banks was going to be difficult without confidence about banks’ futures. “Getting investors to pony up the capital is going to be tricky unless you give us the assurance that banks are too big to fail. So we’re bootstrapping ourselves into a position in which we are doubling down on too big to fail, not removing it.”
Both men were speaking at an Institute of International Finance session within which Wilson Ervin, Senior Advisor to the CEO at Credit Suisse, called for wider use of the so-called bail-in approach to bank resolution, an intended middle ground between taxpayer bailouts and systemic financial collapse. Bail-ins would involve giving regulators authority to force banks to recapitalize using private capital from within the bank rather than public money.
Ervin argued that such an approach would not only make for better resolutions, but help to stop bank failures happening in the first place by reassuring investors. “If you can get to a resolution regime that is clear and predictable and preserves value, I think the markets will value it,” he said. “If we can provide assurance we can get to that type of outcome [a bail-in rather than a bail-out or collapse] that would help to calm some of the issues around the financial sector.”
Investors have mixed views about the practicality of bail-in securities, but clearly want no repeat of 2008. “The events of September 2008 that were most traumatic for investors were the treatment of institutions that came into the grasp of authorities,” Fisher said. “It was not simply the loss of value, or that investors lost money. Each time they touched an institution, they touched it in a different way with a different outcome. That created chaos for investors.”
