DAVOS: Bank failure plan key to regulatory reform

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A bank-funded safety net to absorb large failures could help shield markets and rebuild trust in the financial system, but regulators backing the idea will need to strike a delicate balance.

Finding a solution to the "too big to fail" debate is the main outstanding regulatory headache yet to be addressed in a bid to overhaul the financial industry after the crisis.

But informal talks in the Swiss mountain resort of Davos showed that while banks and regulators agree on the need to build shock absorbers and toughen capital rules to curb bank risk, finding a consensus on how to limit the potential cost to taxpayers of emergency bail-outs could lead to critical delays.

"We need living wills or resolutions," European Central Bank President Jean-Claude Trichet said at the World Economic Forum.

"We have to strengthen infrastructure in order to minimise the fallout of a collapse. It is very complex and multidimensional and we have to work a lot."

Bankers attending the forum said rulemakers and the industry agreed there was a need for a wind-down mechanism for banks, but there was no consensus on what this should look like.

Rescue fund?
One controversial new idea debated at behind-the-scenes talks during the annual gathering was the possibility of creating a so-called "resolution fund" to manage crises at large institutions whose troubles could unsettle the broader system.

The issue is relevant for small countries with large banks, like Switzerland, that want to avoid seeing their economy threatened by a financial collapse, as was the case in Iceland.

The resolution fund, supported publicly by Deutsche Bank Chief Executive Josef Ackermann and Barclays President Bob Diamond, would be set up by imposing a levy on the global banks.

"I very much support it," said Davide Serra, a founder of investment fund Algebris, who holds stakes in several financial institutions. "It means that when there is a crisis, there is private capital, generated by them, that they can use."

Mario Draghi, who heads the powerful Financial Stability Board (FSB), said the FSB was working on a framework for the orderly resolution of bank failures which could involve an agency or equivalent authority.

Yet some industry practitioners were sceptical about setting up a fund or entity, which they said it would introduce moral hazard by bringing in a stronger safety net for banks.

"If we have a fund based on the contribution of all, maybe we would not trade so carefully because we would have this last-resort money -- and then the state," said Warsaw Stock Exchange head Ludwik Sobolewski.

Others pointed to the fact that making the fund operational and reliable could take years -- time the industry and the broader economy can ill-afford.