Containing Runs on Solvent Banks Prioritizing Recovery Over Resolution

The sudden banking defaults in the spring of 2023 proved current prudential norms insufficient to prevent bank distress. Capital and liquidity norms will need to be adjusted. The experience also shows how a lack of credible supervisory tools led to forbearance and finally chaotic public bailouts. An intervention gap arises when viable but undercapitalized banks become at the mercy of runs. Once outflows start to escalate, all that is left is to prepare for resolution and assign losses. We call for new stabilizing measures under Pillar II, as contingent capital and liquidity tools.

A timely recapitalization option requires stronger supervisory powers to activate a timely going concern recapitalization, such as by equity conversion of AT1 CoCo debt. A contingent liquidity measure would be redemption charges (fees) activated automatically upon large outflows of uninsured deposits, related to new SEC norms for institutional MMFs. The goal is to interrupt any self-fulfilling expectation of further outflows. The measure mirrors new SEC norms created for institutional MMFs, the natural benchmark for uninsured corporate deposits. The combination creates a framework for credible early intervention and a chance to steer solvent banks towards recovery rather than resolution and bailouts.