Banks must be allowed to fail to help maintain the market

  • Story by: Catherine Couch
  • Magazine: MortgageAdviser
  • Published Wednesday , July 02, 2008

Legislation to create an orderly regime to exit the banking market is set to be put in place, according to Thomas Huertas, director of the banking sector of the FSA.

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Speaking at the Chatham House Conference in London, Mr Huertas said the regulator's aim was for the legislation to go alongside the established regime for orderly entry into the UK banking market.

He said if unsuccessful firms were not allowed to fail this may result in distorted pricing, leading to a weakening of the viability of businesses that would otherwise have been successful.

However, the failure of banks must be controlled in an orderly way to prevent the collateral damage that may occur to shareholders, depositors and to the economy at large.

At the moment, all banks entering the UK banking market are required to meet what the Financial Services and Markets Act terms as "threshold conditions" - they have the integrity, financial and managerial resources necessary to run a bank.

These conditions must be met at entry and on an ongoing basis.

Subject to banks meeting threshold conditions, entry into the banking sector in the UK is currently free.

There is another process of application when it comes to exiting the market.

Mr Huertas said in a normal competitive market, firms that were unsuccessful failed. This generally led to them becoming insolvent, liquidated or reorganised under the bankruptcy code.

However, he said this process could lead to shareholders losing their money, creditors suffering losses and managers and employees seeking new jobs.

Mr Huertas said the current process ran the risk of creating severe collateral damage on the economy at large and these concerns were why the tripartite authorities had intervened in the case of Northern Rock.

As a result of the Northern Rock experience, the tripartite authorities resolved to introduce legislation to provide them with the ability to handle failing banks and allow for the exit of unsuccessful banks that limited the collateral damage to depositors and the economy.

This would include strengthening the ability of the deposit guarantee system to pay out covered deposits promptly.

Mr Huertas said the legislation would be triggered by the failure by a bank to meet its threshold conditions as determined by the regulator.

If the bank was not able to meet the threshold conditions then the authorities would be justified in executing an early intervention.

Mr Huertas said this would involve stepping in to protect depositors, preserve financial stability and safeguard the public finances.

He said legislation was intended to enable the failure of banks to be resolved in a manner that minimise the collateral damage a bank failure could cause to depositors, the financial system and the economy at large.