The G20 summit in Brisbane will, I hope, mark the end of a major phase in this work with proposals to help end “too big to fail”, including ensuring that banks hold debt that can absorb losses – i.e. be “bailed in” – if the bank fails, and a private sector agreement to provide for stays on derivative contracts during resolutions of failed banks. This stronger international framework has not been an accident. The crisis brutally underlined the degree to which countries were connected to each other through the operation of a global capital market and banking system – and the dangers of regulatory arbitrage between jurisdictions. The FSB and the international standards that have been developed are, it is true, only “soft law”. They are not legally binding. They constrain neither the powers of national regulators to set the rules for their jurisdictions nor the accountability of national regulators to national legislatures. But this soft law is powerful because it is grounded in the recognition by the major jurisdictions that we can only have a globally integrated capital market – and the benefits that brings – if we can agree and implement key common minimum standards. That impulse to work together, internationally, to provide stronger governance of the global financial sector will inevitably wane somewhat the further in time we get from the crisis in which this was born. I don’t think the more powerful, more comprehensive international machinery that has been built since the crisis will disappear. But the challenges will change.
The second big change for the industry is the reduction and I hope removal of the implicit taxpayer subsidy that came from the perception – and as it proved, the reality – that the largest banks were too big to be allowed to fail. New powers to bail-in banks’ creditors, living wills, international standards on the debt that can be bailed in – all of these mean that we are getting closer to be able to say “no bank is too big to fail”. This will change banks’ costs. Being too big to fail, the implicit taxpayer subsidy, reduced large banks’ borrowing costs in relation to their smaller brethren. As we make it more and more possible for a big bank to fail – like any other company – without having to be bailed out by the taxpayer, creditors are realising that they bear more risks than before. The cost of insuring £ UK banks’ senior debt against default was just 8 pence before the crisis. Today that cost has increased by almost a factor of 10, driving up banks’ cost of funds. This is part of the reason why the spread over the risk-free rate on banks’ lending is higher now than before the crisis and is likely to remain so. Put simply, credit was mispriced before the crisis, in part due to the implicit insurance of taxpayer bailouts. Taken together, lower levels of leverage, higher liquidity and the removal of the implicit taxpayer subsidy will mean changes to banks’ business models.