The world's major economies say they will draw up a list of the financial institutions that are so big they pose a threat to the global financial system, a move that promises to meet with stiff resistance from major banks.
Still shaken by the fallout from the collapse of Lehman Brothers Holdings Inc. in 2008, the Group of 20 economic powers pushed ahead with its effort to rid financial markets of the notion that some banks are "too big to fail," and therefore can always count on a government bailout.
The key to changing that perception is ensuring governments have clear authority to take control of failing financial institutions in order to conduct an orderly bankruptcy, said the Financial Stability Board, a collection of financial authorities from 24 countries assembled to co-ordinate regulation and policy.
G20 presidents and prime ministers meeting in Seoul endorsed the FSB proposals, aimed at dealing with financial institutions that are either so large or so integral to the international distribution of money that bankruptcy could trigger another mass credit crisis. The FSB also said "global systemically important financial institutions" should be required to hold larger reserves than smaller banks and be subject to greater scrutiny by regulators.
The proposals are sure to spark fierce lobbying by banks who will want to avoid a designation that will come with extra scrutiny, and requirements to keep more cash in reserve.
Governments must first determine which financial institutions should be put on the list. The G20 gave FSB chairman Mario Draghi, the Governor of the Bank of Italy, the green light to complete work on the methodology for deciding if a bank or insurance company is big enough or interconnected enough to pose a threat to the global economy. Mr. Draghi pledged in a report to the G20 leaders to complete this work by the middle of next year.
"The systemic risk comes from these institutions," Mr. Draghi said at a press conference after the G20 meeting ended Friday. The new standards, once implemented, are "bound to change behaviour," he said.
For the banks and insurers, there is a lot at stake.
Once the list of "G-SIFI's" is complete, Mr. Draghi said in his report that he would propose by the end of 2011 additional measures that national authorities should use to keep any globally systemic firms they happen to regulate in check. These measures would in most cases cost the banks money. They include capital surcharges and a requirement to issue debt that converts to equity at times of stress, or contingent capital. (By the end of 2012, the FSB intends to apply the tougher standards to financial institutions that are systemically important on a national basis.) For firms such as New York-based Goldman Sachs Group Inc. and Britain's HSBC, there will be no avoiding designation. But others will be on the bubble, and will almost certainly do all they can to play down their global reach.
Canada's banks will be among those resisting designation. Royal Bank of Canada chief executive officer Gordon Nixon this week dismissed a report in the Financial Times that said RBC was on a preliminary list of globally systemic banks.
Canadian Finance Minister Jim Flaherty backed Mr. Nixon. But Mr. Flaherty also indicated that Canada's biggest banks were close to qualifying for designation. "Individually, they are not quite big enough, according to the lists that I've seen," Mr. Flaherty said in an interview earlier this week.
The emphasis on the biggest financial institutions is controversial not only with banks. Mr. Flaherty said he is "not a fan" because there's a risk that investors will assume the financial system is sound because the largest banks are well-regulated, forgetting that smaller institutions also can spark problems. French President Nicolas Sarkozy said at a press conference that he had "misgivings" about the focus on too big to fail.
Mr. Draghi said the FSB's focus on systemically important institutions is the right one, saying the issues springing from the collapse of Lehman Brothers have created a "cloud hanging over the financial industry." Until authorities establish a clear system for dealing with the collapse of these institutions, investors will continue to assume governments will bail out the largest of them. "If anything, the situation has become worse after the crisis," Mr. Draghi said.