Ignoring the lessons for effective prudential supervision, failed bank resolution and depositor protection

Abstract

PurposeThe purpose of this paper is to establish three sets of principles – the first for effective prudential supervision of financial institutions; the second for the timely resolution of failed institutions and the management of financial crises; and the third for the successful protection of deposits. It also aims to show how these principles have been eschewed, especially in the USA and the UK.Design/methodology/approachThe first set of principles and examples of their violation are determined from material loss reviews conducted by agency inspectors general, government reports, and academic research. The second set of principles is derived from International Monetary Fund practice and research; violations are those reported in government reports, published research, and press articles. The third set of principles is chosen from those proposed by the Basel Committee on Banking Supervision and the International Association of Deposit Insurers. Violations are those reported in academic and practitioner research and the press.FindingsMany of the three sets of principles have been ignored in the current financial crisis.Research limitations/implicationsExperience in previous crises has shown that eschewing these principles delays the resolution of individual failed institutions, increases resolutions costs, and delays the recover from the crisis. If the legal and regulatory system is to be reformed appropriately to prevent a recurrence, future research must discover the reasons why the principles have not been followed.Originality/valueThe paper assembles three sets of principles and instances where they have been violated in order to help policymakers, practitioners and researchers to focus on where and what reforms are needed to prevent a recurrence of the current severe financial crisis.