Richard J. Herring

Summary 

Bailouts of systemically important financial institutions (SIFIs) have required interventions in the UK, US and euro area totaling over $14 trillion, equivalent to about a quarter of global GDP.  Leaving aside the troublesome but important problem of identifying SIFIs, reliance on bailouts of all creditors and counterparties has not only been very costly to taxpayers, but has purchased financial stability in the short run at the cost of a heightened risk of larger, more frequent, and even costlier crises in the future.

However, as part of its reform efforts, the G-20 has agreed to force SIFIs to develop "internally consistent, firm-specific resolution plans."  Although the G-20 has not outlined the specific provisions that these plans should contain, their overall goal would be to assist regulators by providing them with information on a firm's structure and risk-taking in a way that will help them resolve it without resorting to a government bailout in case of a crisis.   In this paper, Herring outlines what such "wind-down plans" should look like, and describes the benefits that the market would likely see from their use.

In Herring's view, wind-down plans should: 1) map out a SIFI's lines of business so regulators know what corporate entities would be subject to a resolution process in the event of bankruptcy; 2) identify key SIFI interconnections across affiliates; 3) require a SIFI to develop and maintain information that a resolution authority or administrator would use to expedite a wind-down process; 4) identify key SIFI information systems, where they are located, and personnel to operate them; 5) identify key SIFI systems that are systemically relevant and show how they could continue to operate during a wind-down; 6) force a SIFI to consider how its actions affect exchanges, clearing houses and other systemically important elements of the financial infrastructure; 7) identify the precise procedures that a SIFI would follow in a wind-down and update them annually.

Herring argues that having wind-down plans in place for SIFIs would benefit the market in several ways.  The plans would reduce moral hazard by making it clear to creditors and counterparties that a SIFI can be resolved in a way that imposes losses without posing risks to the broader financial system.  The plans should also compel SIFIs to simplify their own corporate structures and reduce their risk exposures while ensuring that regulators in all countries are better prepared to cope with an insolvent SIFI.