Resolution framework is like a bucket with a hole in
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Resolution framework is like a bucket with a hole in

The European resolution mechanism should be agreed next week. But the nature of resolution means that any agreement less than 100% sound is not fit for purpose. Fault-lines in resolution planning are like holes in a bucket — if they exist at all, the bucket won’t work.

The too-big-to-fail era is supposed to end in Europe next week. The European Parliament is set to rubber stamp the agreement on the Single Resolution Mechanism and Single Resolution Fund reached between the Council of Ministers last month, levering into place the final piece of the new architecture that is supposed to set out how to recapitalise or resolve failing banks, and keep taxpayers off the hook for any losses.

But a last-ditch agreement, with a Parliament set to change in May, and national grumblings rumoured in Berlin and London, does not make a solid basis for resolution. It ticks a box on the long list of financial regulation tasks, and the negotiations themselves must have been a heroic effort.

However, it is hard to see it being much use in practice while the stakes remain so high. If a “G-SIFI” — such as UniCredit, Deutsche Bank, or BNP Paribas — was in trouble, the local regulator (or the government behind it) needs extraordinary confidence in the resolution regime functioning as expected to use it at all.

If there is any doubt, such as over calling up guarantees, the legality of triggering resolution, how to impose losses on creditors (which creditors and how much and where), or where final executive decision making power resides, it won’t be useable, and authorities would be better off turning to taxpayers.

The purpose of either a resolution or a taxpayer bailout is to restore confidence in the institution so it can carry on trading. Bailing-in bondholders or raising nominal capital levels are just means to that end.

So a resolution that was founded on shaky political ground would be doomed from the start, because creditors would not have confidence in being paid out by an institution while European authorities wrangled about whose responsibility it was.

Many projects in financial regulation have a chance to iterate towards success. Bank capital and liquidity rules will not be tested until crisis time, but as proposals are being implemented, wrinkles are be ironed out, and practical problems come into focus.

Resolution isn’t like that. Even if resolution authorities get to flex their muscles resolving smaller banks, as Denmark and the UK have experimented with bailing-in senior debt, regulators cannot experiment with resolving a big bank.

The fear factor — what do you do if you aren’t 100% sure resolution will work — is impossible to plan for. However detailed the plans become, however prepared the resolution authorities are, resolution of a big bank is the difference between going paintballing and getting shot at for real. The consequence of failure is potential economic collapse

If the UK really is grumbling about the details of resolution, or if the new Parliament fails to stand behind the agreements signed by its predecessor, this makes resolution uncertain. And that is a fatal flaw. Even a small hole will stop it holding water.

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