Safe to Fail

Banks cannot be made fail-safe. But they can be made safe to fail, so that the failure of a bank need not disrupt the economy at large nor pose cost to the taxpayer. In other words, banks can be made resolvable, and “too big to fail” can come to an end. To do so, the authorities, banks and financial market infrastructures need to prepare in advance for what amounts to a pre-pack reorganization of the bank that the resolution authority can implement over a weekend, if the bank reaches the point of non-viability in private markets (fails to meet threshold conditions). This pre-pack consists of two principal elements: (i) a recapitalization of the bank through the bail-in of investor instruments and (ii) the provision of liquidity to the bank-in-resolution. Creating such a pre-pack solution should form the core of the resolution plans that authorities are developing for global systemically important financial institutions. This paper sets out the conditions that must be met for a bank to be resolvable, the “safe-to-fail” test and the banking structures required in order to meet this test. How banks are organized matters less than what banks, authorities and financial market infrastructures do to prepare for the possibility that resolution may be required. The paper concludes with an agenda for action to ensure that too big to fail is not too tough to solve.