Bank Failures and Contagion: Lender of Last Resort, Liquidity, and Risk Management
Author(s): G30 Working Group on the 2023 Banking Crisis
The study, chaired by William C. Dudley, former President of the Federal Reserve Bank of New York, investigates the bank failures in March 2023 in the United States and Europe. The report analyzes the causes behind these collapses, identifying risky funding structures, significant unrealized losses, and declining profit margins at multiple US banks and a major Swiss bank as critical triggers. It emphasizes the combination of poor business models, weak risk management, and a rapidly changing macroeconomic environment as the factors leading to the failures. In response, the report proposes comprehensive reforms aimed at minimizing contagion risks in the future, enhancing the resilience of banks and the banking system, and reducing the likelihood of future failures.
The proposed reforms are divided into two sets. The first set focuses on limiting contagion when bank failures occur, advocating for enhanced liquidity support mechanisms, an improved lender-of-last-resort (LoLR) regime, potential changes to deposit insurance, and a practical scheme for resolving large banks. The goal is to prevent the spillover of risks and stresses to other banks and the broader system. The second set of reforms aims to reduce the likelihood of banks failing by addressing issues such as better bank governance, improved accounting standards, changes to prudential regulations, and more comprehensive stress tests.
While necessary for financial stability, the report argues that these reforms should not impose significant costs on well-run and transparent banks but should incentivize poorly-run banks to improve their performance. The critical reform among them is establishing a better LoLR system, emphasizing pre-positioning collateral to cover runnable liabilities and encouraging prudent funding structures. The report underscores a holistic and forward-looking approach to these reforms to foster stability and efficiency in the banking sector.
To read the full press release on the report, click here.
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