U.K.'s Alistair Darling Tells Banks To Begin Preparing For Their Own Demise

Darling Said to Tell Banks to Prepare for Unwinding Businesses
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By Gonzalo Vina

July 8 (Bloomberg) -- Chancellor of the Exchequer Alistair Darling today will set out measures to tighten regulation of the British banking industry, requiring institutions to plan for their own demise, a person familiar with the plan said.

The proposals from the Treasury will require banks to keep on file instructions on how to unwind their own businesses to assist regulators in a rescue. Darling will give details of the plans in a statement to Parliament at 12:30 p.m. in London.

The rules are aimed at preventing a repeat of turmoil in financial markets that forced Britain to rescue Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc last year. Prime Minister Gordon Brown’s government is coordinating the overhaul with President Barack Obama’s administration in the U.S.

“It’s very important for governments to move forward because impetus will wane as the crisis lessens and the lobbying efforts of the banks get even stronger,” said Richard Portes, a professor of economics at London Business School.

The Treasury is adopting all the recommendations made in March by Financial Services Authority Chairman Adair Turner, who called for a “revolution” in the way the industry is governed. He suggested banks hold more capital and hedge funds be more open with regulators. He wants mortgage loans not to exceed the value of the property they are secured against.

Industry Concern

Those proposals already have attracted criticism. The British Bankers’ Association has said the plan to reorganize units to lower risk may lead some lenders to relocate abroad. Yesterday, the lobby group said it wouldn’t comment further until it has time to analyze the plan.

Parliament will start work on drafting laws to implement Darling’s plan after its summer recess ends in October. The Treasury will issue a draft of proposed legislation today.

Darling will redraw British rules to force bondholders to share losses with equity owners during bankruptcy and take steps to disclose trades of complex derivatives, the person said.

“What we have now is not sufficient and having a resolution mechanism in place would make a tremendous difference,” said Viral Acharya, professor of finance at Stern School of Business in New York. “Governments now have to make sure they can wind down banks in a smooth manner.”

The chancellor also is planning to ask banks to protect deposit-taking operations from more risky trading businesses, requiring institutions including HSBC Holdings Plc and Barclays Plc to ring-fence investment banking units, people familiar with the plan said on June 24.

Derivatives Trading

Treasury Minister Paul Myners on June 18 said the U.K. will also force institutions trading complex derivatives to hold more capital, mirroring U.S. plans to curb risk in the $560 trillion market blamed for deepening the global recession.

At a less-developed stage will be proposals to beef up the role of the FSA and the Bank of England, which will be given new authority to police banks and assess risks to the stability of the economy from asset-price bubbles.

Today’s plan also won’t tackle the issue of executive pay, identified by Darling and Brown as sources of instability in financial markets. Instead, Darling will wait until later this month for a report on the issue by David Walker, a senior adviser at Morgan Stanley, before recommending steps.

The worst financial crisis since World War II has forced the British government to extend more than 40 billion pounds ($65 billion) of aid to banks and take on at least 1.4 trillion pounds of liabilities, more than the value of the economy.

Tools to Use

While plans exist at national and global levels for greater oversight, there is disagreement on who will do it and what tools they will use.

The government is seeking to find ways of coping with institutions deemed “too big to fail,” something Bank of England Governor Mervyn King said last month needed to be addressed to limit risks to taxpayers. He suggested that banks should be required to write “a will” describing how administrators could unwind their assets.

“Making a will should be as much a part of good housekeeping for banks as it is for the rest of us,” King said on June 17. “And it would be sensible for the various authorities to work across national boundaries to identify detailed plans for how each large cross-border financial institution could be wound down.”

As part of the effort, the government wants all investors financing banks -- whether through companies, equity or bonds -- to share in any losses when an institution is rescued. Shareholders suffered the biggest losses when the government took control of Lloyds and RBS, and the Treasury wants greater discipline elsewhere in markets.

The person said British plans will go no further than those outlined in the U.S. by Obama.

British officials are pushing for a common approach with American and European regulators that would centralize the settlement of derivative trades through a web of clearinghouses.

To contact the reporter on this story: Gonzalo Vina in London at gvina@bloomberg.net.
Last Updated: July 7, 2009 19:01 EDT