Ensuring secured creditors face losses when a financial institution fails could help rein in excessive risk-taking and strengthen the financial system, a top U.S. banking regulator said.
Federal Deposit Insurance Corp Chairman Sheila Bair told a group of international bankers on Sunday that officials might want to consider the very strong medicine of limiting secured claims to 80 percent, although she said such a proposal would need to be carefully weighed.
She said curbing claims would encourage secured creditors, who are protected from losses when a bank fails, to more closely monitor the risks a bank is taking and could speed up the process when an institution needs to be wound down.
This could involve limiting their claims to no more than say 80 percent of their secured credits. This would ensure that market participants always have 'skin in the game', Bair told a meeting of the Institute of International Finance here.
While Bair said the far-reaching proposal could have a major impact on the cost of funding for banks subject to any official resolution mechanism, it also had advantages.
A major advantage is that all general creditors could receive substantially greater advance payments to stem any systemic risks without the extensive delays typically characteristic of the bankruptcy process, she said.
Obviously, the advantages and disadvantages need to be thoroughly vetted. In any event, there is a serious question about whether the current claims priority for secured claims encourages more risky behavior, Bair added.
The U.S. Congress is currently considering wide-ranging regulatory reforms that would give regulators the authority to resolve -- or wind down -- systemically important non-bank institutions. The FDIC already has such authority for deposit-taking banks.
Bair said officials around the world should consider resolution regimes that cover both banks and non-bank operations of financial conglomerates, whether or not their failure might spark wider troubles for the financial system.
She said resolution authority should include the ability to reject burdensome contracts, sell assets, resolve claims, and establish and operate bridge financial companies.
(Reporting by Tim Ahmann; Editing by Ruth Pitchford)