The only country to solve the Too Big To Fail problem is China – the one emerging market with globally systemically important banks. The reason China is in this advantageous position is because its major banks are state-owned and the government has $3800bn in foreign exchange reserves as a bail-out fund.
There are reasons to be concerned about Chinese bank assets, with the country's economy slowing down, the property sector under pressure and the growth of a large-scale shadow banking sector in which much of the risk may still find its way back to the banks. But whatever happens, it is a fairly safe bet that no large bank will be allowed to fail. State-owned banks only fail if the state fails – hardly a realistic prospect in China’s case.
For this reason it is no surprise that China has been excluded from the Financial Stability Board’s (FSB's) proposals for total loss-absorbing capacity (TLAC). The FSB’s mission is to make big banks resolvable in the market and to have investors take the hit rather than taxpayers. To achieve this, TLAC should be set at 16% to 20% of risk-weighted assets and split two-thirds equity and one-third debt, according to FSB proposals to this weekend’s G20 meeting in Brisbane.
The key feature is a layer of subordinated debt designed to be bailed in at the same as equity but before losses touch senior debt. It sounds fine in theory but no one can possibly know if pure market solutions will work in the case of a global banking crisis until we get there. It depends for a start on regulators and politicians of different jurisdictions sticking to the agreed framework and trusting each other even as bank depositors are queuing around the block for their money.
By contrast, Chinese banks will be less susceptible to panic as they will retain their sovereign guarantee. “The exemption reflects a distrust of a market-driven approach to bank resolution from some regions and we expect the carve out to be a longer term feature even though the proposals say the exemption would apply ‘initially’,” says a Fitch Ratings’ report.
Chinese and Western economic models are so far apart that there is no way common regulation could draw them both in. US and European governments want to stay as far away from bank ownership as possible while China’s conclusion from the financial crisis is that markets have their limits and cannot be wholly trusted.
The result is to deliver to Chinese banks a funding advantage as they go global. Investors will surely demand less return to lend to Chinese banks retaining a sovereign guarantee than to institutions which have been restructured to try to remove it. Having banks that are too big to fail is fine if you can afford it. China still can, the West cannot.
Brian Caplen is the editor of The Banker.
