I.M.F. CHIEF CALLS FOR "FIRE BRIGADE" TO AID EUROPEAN BANKS / THE NEW YORK TIMES ( RECOMMENDED READING )

March 19, 2010

I.M.F. Chief Calls for ‘Fire Brigade’ to Aid European Banks

By MATTHEW SALTMARSH

PARIS — Europe should have a “fire brigade” backed by funds from governments and the private sector to deal with failures of large banks, the managing director of the International Monetary Fund said Friday.

“What I think is needed is a European Resolution Authority, armed with the mandate and the tools to deal cost-effectively with failing cross-border banks,” the monetary fund’s chief, Dominique Strauss-Kahn, said in the text of a speech delivered to a conference on banking supervision in Brussels.

“Fire damage can best be contained when the fire is detected and extinguished early,” Mr. Strauss-Kahn said. “But even the best fire prevention system needs a fire brigade.”

European Union members have agreed to the principle of burden-sharing for cross-border banking workouts, but they have yet to make it operational and binding.

In the United States, the Senate is also debating an overhaul of financial regulation aimed at, among other things, buffering the economy from systemic threats like those posed by companies like Lehman Brothers and the American International Group in 2008.

The recent financial crisis exposed several flaws in Europe’s financial regulations, including the lack of any well-defined mechanisms for dealing with larger lenders that operate across national borders.

Several European banks, like KBC of Belgium and Swedbank of Sweden, expanded aggressively in the countries of Central and Eastern Europe in the last decade, then ran into difficulties when the crisis hit.

Support for important lenders then was worked out in an ad hoc manner, by national supervisors acting with colleagues from other countries, and sometimes multilateral institutions like the European Bank for Reconstruction and Development, which is based in London.

This week, the Basel Committee of the Bank for International Settlements issued a series of recommendations, yet to be agreed nationally, intended to strengthen cross-border bank support tools.

The 44-page final report of the cross-border group called for “firm-specific contingency planning” that would help the most interconnected financial companies survive a crisis or, if necessary, be dismantled in an orderly fashion, without risking a global financial crisis.

Nout Wellink, the president of the Dutch central bank and the chairman of the Basel Committee, said its recommendations made “meaningful progress toward addressing systemic risk and the ‘too big to fail’ problem.”

In his speech, Mr. Strauss-Kahn said the new authority should be able to bail out “at least the major cross-border banking groups, as well as all banks running large-scale cross-border operations.”

A mechanism should be established to ensure that the losses “are borne in the first place by shareholders and holders of equitylike instruments, and in the second place by uninsured creditors,” he said.

“As much as possible, the system should be prefinanced by the industry — including through deposit insurance fees and any levies on the relevant financial institutions.”

But, Mr. Strauss-Kahn said, there would also have to be a role for government. “To be robust, such a system needs access to financing and a fiscal back-up mechanism for any net resolution costs,” he said.
Speaking at the same conference, the president of the European Central Bank, Jean-Claude Trichet, endorsed a proposal to limit the disruptive potential of credit-default swaps as a step toward preventing finance from spiraling “out of control.”

Mr. Trichet added his backing to proposals for default swaps to be traded on a central clearing platform, as is routine for other kinds of derivatives. Currently most default swaps, a form of insurance against default by bond issuers, are traded directly between issuers like investment banks and buyers like hedge funds. A clearinghouse would allow regulators to see who is buying and selling the swaps, which some politicians, including the leaders of Greece and Germany, have blamed for inflaming the Greek debt crisis.

Sewell Chan contributed reporting from Washington, and Jack Ewing from Frankfurt.