BIS Review 144/2009  5  Resolution of bank failures If recovery plans prove wanting, then distressed banks need to be “resolved” – laid to rest, but without undermining crucial economic services. Sometimes the best course will be a straightforward, whole-bank liquidation, with retail depositors receiving a payout from the insurance fund. But, alternatively, resolution can involve selling the deposit book – and so the vital payments services – to another bank. Good assets might go with the deposits, or be transferred elsewhere. Bad (or at least unsaleable) assets go into run off. Choosing the best course is central to effective resolution planning. To split up and transfer the different parts of a bank, the authorities obviously need specific and extensive powers. The broad model is provided by the Deposit Insurance Corporations of the USA and Canada. The UK has recently introduced such powers, having learnt the hard way that we needed them. A number of other countries in the EU adapt their normal corporate insolvency regime for the special structure of banks, but do not all have the option to break up and transfer different parts of the business. This is the subject of the recent consultation paper published by the European Commission. 5 In the UK, the Bank of England has become the Special Resolution Authority. We have been helped by the hands-on operational expertise necessary for our market operations and for running the wholesale payments system. This new responsibility has given us an interesting vantage point on the preconditions for effective resolution.
This part of the reform agenda – the restructuring of the continuing shadow banking system – must not be neglected. Market maker of last resort? The purpose of providing liquidity insurance to banks is well known – having been developed since Bagehot’s day and before. It serves us well to put a finger in the dyke, with a view to preventing a liquidity panic developing unnecessarily into a solvency problem through the forced-sale of assets. But this crisis has reminded everyone that it is not only firms that can suffer liquidity runs. Markets can too. Liquidity insurance facilities that underpin banks' funding are obviously helpful to preserving market liquidity, as they increase the probability of bank-dealers being able to finance unwanted inventory. But arguments have been advanced during the crisis that the authorities should be able to act more directly to preserve market liquidity, especially if bank-dealers withdraw from market-making because they become capital constrained. That is, essentially, the origin of suggestion that central banks should stand ready to act as Market Makers of Last Resort. 2 As the amount of credit that gets intermediated via markets rather than via institutions grows, the need for a MMLR grows too. This is by no means straightforward, and not only because it is not central to our inheritance. Whereas lending to a bank does with certainty give that bank more liquidity, entering a market as a buyer does not automatically enhance the liquidity of that market in a sustainable way.