Bank crisis plan leaves some gaps unplugged

By Stewart Fleming

Date: 19/05/05

Experts in financial stability are warning that although a new agreement on crisis management in the EU is a big step forward in moves to protect Europe's financial markets, it does not plug all the potential gaps in official defences against a major banking crisis.

"This agreement is an encouraging step forward in dealing with an important problem. But we cannot be sure how finance ministries dealing with a cross-border crisis would decide who was actually responsible for providing the funds to bail out a very large bank for example," said a former senior bank regulator.

The informal Ecofin meeting last weekend (13-14 May) reached agreement on a new memorandum of understanding between central banks, banking supervisors and finance ministries on how they would work together in a 'systemic' cross-border crisis - that is one threatening the financial system. The previous accord, agreed in 2003, covered only central banks and bank supervisors and provided that central bank 'tools' such as liquidity provision, could be deployed in a crisis. But no clear procedures were put in place to involve finance ministries if taxpayers' money had to be put at risk to head off an insolvency.

One expert described this as "the weak link in the crisis management chain".

The new agreement aims to close the gap. It is not being published, in part because of fears of creating so-called "moral hazard", encouraging banks to take excessive risks in the belief that they will be rescued.

But according to a former financial market regulator it is unlikely that the gaps in the defences against a financial crisis have been filled completely. "These agreements are usually about process," he said. Only when two finance ministries were actually facing the need to provide money to bail out a failing bank would they face up to the question of which countries' taxpayers were going to take on the risk, he added.

The informal Ecofin meeting last of 13-14 May 2005 reached an agreement on a new memorandum of understanding between Central Banks, banking supervisors and Finance Ministries on how they would work together in a 'systemic' cross-border crisis - that is one threatening the financial system.