Vol 8 (2011) - Issue 5

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Too Big To Fail?: Is This the Right Question and is the Response to the Financial Crisis the Correct One?

At the Lord Mayor’s Mansion House banquet on 17 June 2009, the Governor of the Bank of England, Mervyn King, cited the much repeated quote 'If some banks are thought to be too big to fail then, in the words of a distinguished American economist, they are too big'. Whilst megabanks formed by growth and consolidation are increasingly complex and may present the potential for unusually large systemic risks, small is not always beautiful as the recent failure of Southsea Mortgage & Investment Company demonstrated.

Over recent years, a number of measures have been taken, both domestically and internationally, to address the global financial crisis. These range from the introduction of the Banking Act 2009 ('the Banking Act') in the UK to the Basel Committee’s tightening of capital adequacy ratios and the introduction of rescue and recovery plans ('Living Wills') for financial institutions. Most recently, we have a Government White Paper dealing with UK financial regulation which considers a proposed new approach to financial regulation as a blue print for reform. The EU has also undertaken a consultation which in due course will lead to a framework for a future EU-wide bank resolution regime.

The plethora of measures being driven forward domestically and internationally requires a delicate balancing act. Whilst seeking to instil rigid risk management they must not stymie the UK’s financial services sector as a major driver of the UK economy. In cases where failure cannot be avoided, it is vital that the wider Special Resolution Regime and the new liquidation and insolvency procedures introduced by the Banking Act are both flexible and robust enough to deliver the optimum solution in the event of future crises. To assess whether the new regimes have the potential to deliver, let’s briefly look at each in turn.


Banking Act 2009

We now have a Special Resolution Regime, including new insolvency procedures for banks in the UK which has already been tested. These are contained in the Banking Act which came into force on 29 February 2009. Prior to that there was no dedicated regime.

The new legislation was driven by a series of financial institution failures between 2007 and 2009, including Northern Rock, which saw the first run on a UK bank in over one hundred years. This was followed by the fall of Lehman Brothers, the major Icelandic banks such as Landsbanki, Heritable and Kaupthing, all having a significant impact in the UK. Smaller banks, including London Scottish Bank, were placed into old-style administration during this period whilst significant bail outs and mergers changed the face and ownership of our high street banks.

The overriding objective of the Banking Act was to bring about financial market stability. It was first used in the case of Dunfermline Building Society which was placed into Building Society Special Administration on 30 March 2009. At the core of the Banking Act is the Special Resolution Regime which gives our Tripartite Authorities (the Bank of England, the FSA and the Treasury) various options and powers to address failing banks. The new regimes fall into two broad categories, the first being stabilisation measures to be used pre-insolvency.

We now have three pre-insolvency stabilisation measures which in short are:

1. the transfer to a private sector purchaser ('PSP') under which the Bank of England has the power to transfer all or part of a bank to a PSP;

2. the transfer to a bridge bank under which the Bank of England can transfer all or part of a business to a bridge bank being one owned and operated by the Bank of England.

3. the transfer to temporary public ownership ('TPO') where the Treasury can transfer shares in a bank to a nominee company wholly owned by the Treasury.


In addition to the stabilisation measures to be used pre-insolvency, the Banking Act also introduced new insolvency procedures to deal with a bank which has failed. There are two new procedures; a Bank Insolvency Procedure ('BIP') – essentially a liquidation – and a new Bank Administration Procedure ('BAP').