bank defaulting, thereby tackling at source these systemic externalities. And significant public policy progress has been made on this front, with the FSB publishing (and the G20 approving) some Key Attributes for Effective Resolution Regimes during the course of the past 18 months. A key component of these plans is the ability to impose losses on private creditors—so-called ‘bail-in’—rather than have those losses borne by taxpayers. As with systemic surcharges, the issue here is not to so much the bail-in principle, but its application in practice. Bail-in, whether of big banks, sovereigns or companies, faces an acute time-consistency problem. Policymakers face a trade-off between placing losses on a narrow set of tax-payers today (bail-in) or spreading that risk across a wider set of tax-payers today and tomorrow (bail-out). A risk-averse, tax-smoothing government may tend towards the latter path—and historically has almost always done so, most notably in response to the present financial crisis. Next time may of course be different. But the market is sceptical. For example, in the US the Dodd-Frank Act on paper rules in future bail-in and rules out future bail-out. Yet market expectations of state support for US banks are higher today than before the crisis struck and are unchanged since Dodd-Frank became law. The time-consistency dilemma, at least in the eyes of markets, is as acute as ever.
(c) Structural reform: One way of lessening that dilemma may be to act on the scale and structure of banking directly. Several recent regulatory reform initiatives have sought to do just that, notably the ‘Volcker rule’ in the US, the ‘Vickers proposals’ in the UK and, most recently, the ‘Liikanen plans’ in Europe. While different in detail, each of these proposals shares a common objective: a degree of separation or segregation between investment and commercial banking activities.
In principle, these ringfencing initiatives confer both ex-post (improved resolution) and ex-ante (improved risk management) benefits. Because they act on banking structure, they have a greater chance of proving time-consistent. While this is a clear step forward, those benefits are only as credible as the ringfence itself. The issue raised by some