Making banks resolvable is a key component of the regulatory reform programme enacted in response to the crisis. A resolvable bank is one that is “safe to fail”: it can fail and be resolved without cost to the taxpayer and without significant disruption to the financial markets or the economy at large.
This paper designs such a bank. The design’s key feature is the separation of investor obligations from customer obligations at the operating bank. This is broadly achieved where the bank issues customer obligations, such as deposits and derivatives, and the parent issues investor obligations to third parties with the investment of the parent in the daughter bank serving as the transmission link for losses at the bank level to losses to investors at the parent level. This transmission of losses to the parent serves to recapitalise the bank-in-resolution. This in turn assures the solvency of the bank-in-resolution and provides the basis for the operating bank to obtain liquidity and continue customer operations. In sum, investors, not taxpayers, bear the cost of resolution and the bank continues to perform critical economic functions.
The design works not only for a bank in a single jurisdiction, but also for internationally active banking groups with branches and/or subsidiaries in foreign jurisdictions. Indeed, the design can form the basis for international cooperation among resolution authorities and central banks, so that they can establish“constructive certainty” as to the path they would follow, should a global systemically important bank need to be resolved.
